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The Best of
All Worlds

Globalizing the Knowledge Economy
Federal Reserve Bank of Dallas n 2006 Annual Report

Contents
A Letter from the President . .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  . 1
The Best of All Worlds . .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  . 3
Senior Management . .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  . 29
Boards of Directors. .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  . 30
Officers and Advisory Councils. .  .  .  .  .  .  .  .  .  .  .  .  . 32
Financial Statements. .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  . 33
Notes to Financial Statements. .  .  .  .  .  .  .  .  .  .  .  .  .  . 39
Volume of Operations. .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  . 54

ON THE COVER
The Internet Explosion. The graphic, created in one
day on a single computer, represents the Internet’s
networks and nodes as of November 2003. The
colors correspond to geographic regions: orange for
North America, yellow for Asia–Pacific, red for Latin
America and the Caribbean, and green for Europe,
the Middle East, Central Asia and Africa.
Photo courtesy of Barrett Lyon, The Opte Project.

A Letter from the President
This is the second year I have
had the privilege of serving the
employees of the Dallas Federal
Reserve and its branches in El
Paso, Houston and San Antonio.
During that time, the good
women and men who run our operations and conduct our business
have raised the Bank’s profile to
new heights, as evidenced by the
operating statistics at the end of
this annual report. Last year they
processed over $1 trillion in the
form of 940 million paper checks
and more than a quarter billion
electronic checks. Some 6.1 billion banknotes worth over $100
billion passed through our vaults.
Dallas Fed staff supervised
and regulated 38 state member
banks, 450 bank holding companies, and 29 agencies and representative offices of foreign banking organizations in the Eleventh
District. They worked hard to
promote financial literacy and
community development so that
citizens in our district will be
better equipped to manage, safeguard and improve their financial
well-being. And they sent me out
on the hustings to give dozens of
speeches, mercilessly inflicting me
on the public and the economics
profession.
My favorite theme has been
the need to better understand the
ramifications of ongoing global
economic integration for our
economy and the conduct of monetary policy. The nexus of globalization and monetary policy is
the Dallas Fed’s top research priority. We have been chewing on
this topic for two years, and I am
gratified by the progress we have

made in understanding it and the
interest we see in academia and
business and within the Federal
Reserve System. We are onto
something.
“The Best of All Worlds,”
this year’s annual report essay by
our chief economist, W. Michael
Cox, and senior economics writer,

Federal Reserve Bank of Dallas



Richard Alm, contemplates how
globalization changes the economy’s gearing. It examines 10 ways
a more integrated world economy
impacts productivity and costs.
All these channels are real, rather
than monetary, in nature. But
because they affect economic
growth, they have potentially

2006 Annual Report

far-reaching implications for Fed
policymakers.
The Fed’s mandate calls
for keeping inflation low while
maintaining maximum sustainable economic progress, a charge
we cannot fulfill without understanding and weighing the forces
driving productivity. Getting
more output from existing labor
and capital allows the economy to
grow faster without creating price
pressures. We saw this vividly in
the 1990s, when the IT revolution
led to surging productivity, lower
costs and faster growth. The Fed
understood that increased supplies of goods and services—not
inflationary excess demand—fueled the expansion, and it wisely
let the economy seek a higher
growth rate.
The technologies that shaped
the 1990s are also spurring globalization, which in turn increases
market size, competition, specialization, capital flows, knowledge
transfers, returns to scale and
the other factors this year’s essay
identifies. These factors all conspire to raise productivity’s level
or growth rate—or both.
Higher productivity lowers
costs. In this fundamental way,
globalization raises the economy’s speed limit, so policymakers can let the economy expand
at rates that might once have
been considered unsustainable.
In a globalized world, faster
U.S. growth might not carry
the same inflationary implications that it did in a more closed
world. Foreign growth may also
matter for productivity and cost
here at home.
This year’s essay underscores
how the world is fast becoming one big, integrated economy.

Consider a Barbie doll that’s
designed in America and made
in China from Taiwanese plastic pellets, Chinese cloth and
Japanese nylon hair, then marketed to a child in Dallas. Is that
an American product or an Asian
one? When a laptop computer in
Boston performs remote heart
surgery on a patient in Milan,
is the procedure taking place in
America or in Europe? When
folks in the U.S. and other countries can work together so seamlessly, how can we pull them apart
with the data? Perhaps we should
care as much about output gaps,
capacity utilization and unemployment rates elsewhere in the
world as we do about our own.
We cannot make good judgments without proper measuring sticks. Data that do not reflect the world in which we live
increase the chances for errors
in decisionmaking. We need to
develop much better measures
for the global economy, particularly since services are becoming
increasingly traded. Today, our
most detailed measures of economic performance pertain to
goods, a shrinking segment of our
economy. We can tell you about
agriculture and manufacturing in
excruciating detail but have relatively little data about the fastgrowing services sector—now 82
percent of U.S. employment.
Globalization’s lower costs
make assessments of living standards more elusive. GDP, our traditional yardstick, measures the
economy based on what things
cost, not on what they contribute to well-being. This is particularly problematic for the growing
number of goods with decreasing
average production costs.

2006 Annual Report



Will India’s GDP adequately
reflect how much more living
standards rise when four families
buy $30 cell phones than when
one family buys a $120 cell phone?
I doubt it. The same contribution
to India’s GDP generated by the
$120 phone would mean three
families did without. The more
globalization drives down costs,
the more GDP growth understates true advances in living standards. Getting the right measure
of the advance might well alter
our notions of economic progress,
with ramifications for how we approach the goal of price stability.
The Dallas Fed will be taking its study of all this to the next
level with the establishment of
the Globalization and Monetary
Policy Institute. I am deeply indebted to the prominent scholars and practitioners who have
agreed to serve as our founding
advisory directors: Charles Bean
of the Bank of England, John
Taylor of Stanford University,
Martin Feldstein and Ken Rogoff
of Harvard University, Glenn
Hubbard of Columbia University,
and Otmar Issing, former chief
economist and executive board
member of the European Central
Bank.
We have high hopes that the
institute will further the understanding needed to conduct policy
in a globalized world so we can
meet our congressional mandate
to foster price stability and maximum sustainable employment.

Richard W. Fisher

Federal Reserve Bank of Dallas

The Best of All Worlds
Globalizing the Knowledge Economy
In 2001, a surgeon in New
York removed the gallbladder
of a patient 3,870 miles away in
the French city of Strasbourg, a
medical miracle made possible by
robotic surgical tools and highspeed communications. Doctors
now perform thousands of remote surgeries a year, including
heart bypasses, kidney transplants, hysterectomies and prostate procedures.
In an even more mind-boggling
feat, a laptop computer in Boston
last year guided instruments as they
performed heart surgery—unaided
by human hands—on a patient in
Milan, Italy. A $1.3 million computerized system relied on intricate software that incorporated
surgeons’ techniques and data
from 10,000 previous robotic
operations.
The conquest of physical distance to deliver medical services
testifies to the benefits of globalizing the Knowledge Economy.
Our greatly expanded capacity

to calculate, communicate and
coordinate has toppled barriers
that for centuries constrained so
many economic activities. It has
led to immensely increased productivity, thus lowering costs and
raising living standards in ways
unimaginable just a few years ago.
We’re only beginning to fathom
the consequences.
As knowledge spreads in our
globalizing economy, it unleashes
powerful forces that redefine
fundamental economic relationships. In one industry after another, lower transportation and
communication costs have knit
together far-flung companies and
workers, expanding local markets
into worldwide ones.
A more integrated global
economy generates new competition, identified since the days of
Adam Smith as a key to delivering more output at lower prices.
Larger markets bolster incentives
for innovation, the wellspring of
economic progress. They open new

Federal Reserve Bank of Dallas



possibilities for specialization,
which channels factors of production to their most efficient uses.
Globalization boosts foreign
investment by freeing scarce capital to seek its highest return anywhere in the world. Companies
can find and manage a broader
range of inputs, the raw materials for more efficient production
methods. Where fixed costs are
high and marginal costs low, globalization extends economies of
scale to output levels beyond the
scope of national markets. The
connection of competitors and
capital from all parts of the world
reduces entry barriers in highfixed-cost industries, eroding the
monopoly power that keeps prices
high.
Knowledge and technology
spread more readily, loosening
the restraints that shackle progress. Production becomes more
efficient and consumption less rivalrous. Indeed, a knowledge-rich
economy changes the very nature

2006 Annual Report

of consumption as a growing
number of goods and services are
distributed to new buyers without
diminishing others’ consumption.
Human beings have always
put their brainpower to use, but
today’s explosion of knowledge
is playing out in an era in which
national borders are less of an
impediment to the movement
of goods, services, money, people
and ideas. The combination of
knowledge and globalization provides the U.S. with the best of all
worlds—the benefits of not only
our nation’s intelligence but the
entire planet’s.

Gaining Knowledge
on a Global Scale
Today’s world teems with
knowledge. Remote robotic surgery exemplifies our store of
highly specialized knowledge, the
vast scientific and entrepreneurial
expertise behind our era’s great
technological leaps. More than
5 million researchers are at work
around the world, literally creating knowledge. We’re operating
more think tanks and publishing more scholarly articles than
ever. Each year, the world adds
mountains of new information in

2006 Annual Report



computer files and on paper, film
and compact disc—enough to
fill 37,000 Libraries of Congress,
with its 17 million volumes. (See
Exhibit 1.)
Over the past 35 years, literacy spread from 63 percent to
82 percent of the world’s population. Average years of schooling
rose from 5.1 in 1970 to 6.7 today. The global supply of college
graduates has more than doubled
since 1980.
Almost 900 million personal
computers are in use worldwide—
roughly one for every seven people. The best of them are 40 times

Federal Reserve Bank of Dallas

Exhibit 1

In the Know

Today’s economies are knowledge-rich. The world is better educated, with far more resources dedicated to science
and research than just a quarter century ago. Technology facilitates the collection and management of information, as well as its spread around the world.
World Knowledge Indicators
College degree holders, total
Share of population, ages 25+
Bachelor’s degree graduates
Doctoral degree graduates
Science and engineering doctorates
Science and engineering doctorates in China
College professors worldwide
Think tanks
R&D researchers
R&D spending
Scientific articles published
Human genome base pairs decoded
Wikipedia articles
Patent applications
Licensing revenue
Information Infrastructure and Use
Personal computers
per 1,000 people
Landline phones
per 1,000 people
Cell phones
per 1,000 people
Countries connected to the Internet
Secure Internet servers
Internet web sites
Host computers connected to the Internet
Internet storage (terabytes)
Semiconductor sales
IT capital stock (U.S.)
Digital video recorders
Information Capacity and Speed
Portable memory storage (megabytes)
Data transfer rates (kilobytes per second)
Processor speed (millions of operations per second)
Broadband subscribers
Annual information flow via TV, radio, Internet, e-mail, IM, phones (terabytes)
Communication Use
International telephone traffic (minutes)
Internet users
per 1,000 people
E-mail accounts
Voice over Internet protocol subscribers
TVs per 1,000 people, worldwide
TVs per 1,000 people in China; India

Federal Reserve Bank of Dallas



Now
212 million
9.1%
9.1 million
293,085
154,710
10,096
8.5 million
318
5.1 million
$667 billion
698,726
all 3.1 billion
5.3 million
1.1 million
$109.8 billion

Then
82 million
5.3%
4.3 million
114,808
57,217
125
3.8 million
160
1.9 million
$276 billion
466,419
0
0
701,151
$10.8 billion

1980
1980
1981
1983
1983
1985
1980
1980
1985
1981
1988
1990
2001
1985
1980

898 million
140
1.2 billion
217
2.7 billion
416
209
401,050
110 million
395 million
532,897
$248 billion
$1.05 trillion
17.4 million

131 million
19
333 million
75
11.2 million
2
20
0
9,300
313,000
0
< $1 billion
$16.7 billion
0

1990
1990
1980
1980
1990
1990
1990
1990
1990
1990
1990
1980
1980
1990

16,384
100,000
21,600
217 million
18.8 million

1.44
9.6
16
0
n/a

1990
1990
1990
1990
—

145 billion
1.02 billion
157
1.4 billion
24 million
287
382; 84

8.7 billion
2.6 million
.5
0
0
126
9; 6

1980
1990
1990
1985
1990
1980
1980

2006 Annual Report

more powerful than the machines
of just a decade ago. Our capacity
to store knowledge has become
immense. A single USB memory stick can hold as much data
as nearly 11,400 of the 3.5-inch
diskettes that were standard issue in the early 1990s. A decade
and a half into its existence, the
Internet can store the equivalent
of 62 stacks of 500-page books
reaching to the moon.
Connectivity puts worlds of
knowledge at our fingertips.
Internet users can tap into more
than 110 million web sites.
Wikipedia delivers a vast store
of information in a fifth of a
second at virtually no cost. (See
Exhibit 2.) The Internet Archive’s
Wayback Machine offers a digital library of 85 billion documents, images and audio files—a
massive compendium of all the
information ever posted on the
Exhibit 2

Internet. The free site receives
300 hits a second.
All this information would be
overwhelming without the tools
to find what we want. Digital
technologies make it easy to
scour the world for news, images,
business opportunities, job openings, suppliers, and the best prices
for all sorts of goods and services.
In the U.S. alone, Internet users
conducted an average of 213 million searches a day in April 2006.
And it didn’t cost them much.
Like many Internet offerings,
search engines deliver highly valued services at minimal cost—in
fact, free at the margin.
We possess not only more
knowledge but also better and
cheaper ways of sharing it.
Information once traveled at
the speed of foot, hoof and sail.
Telegraphs, telephones and teletype machines greatly increased

the information speed limit—
but they were expensive and not
widely used. Only in the past
decade or so have costs fallen
enough to ignite a global communications explosion.
Go back in time and consider
the telegraph, an 1837 invention
that succumbed to progress in
2006, when Western Union discontinued commercial service.
In terms of U.S. wages, the cost
of a 10-word international message dropped from 93 hours’ pay
in 1900 to 11 hours’ in 1930 to
84 minutes’ in 1960. Despite
the plunge in cost, international
telegrams never reached prices
ordinary Americans deemed a
bargain. On average, they sent
just one overseas telegram every
six years from 1930 to 1960. (See
Exhibit 3.)
Real costs plummeted for U.S.
international telephone service,

An Encyclopedia That Speaks Volumes

Measured in words, Wikipedia
passed 100 million in January 2004,
1 billion in February 2006 and 1.7
billion in September 2006. Just as
important, the online encyclopedia
dispenses information in Swedish,
Russian, Chinese, Portuguese and
245 other languages—a testament
to the Internet as a truly global information source.

Words (millions)
1,800

1,600
Other
Swedish

1,400

Russian
1,200

Chinese
Portuguese

1,000

Polish
Dutch

800

Italian
Spanish

600

Japanese
French

400

German
English

200

0
2001

2006 Annual Report

2002



2003

2004

2005

2006

Federal Reserve Bank of Dallas

Exhibit 3

Ties That Bind

Communications spur globalization because they facilitate the spread of knowledge and information across borders. International connections were once prohibitively expensive, but cheaper telephone calls and the Internet
have given them a powerful boost in recent years.
Hours of work
100

Telegrams per person
1

Cost per 10-word
international telegram

.5

10

International
telegrams sent

Cheaper Communications
The Telegraph
The work-hour cost of sending
a 10-word message overseas fell
98 percent over 60 years. International telegram traffic, however,
peaked in 1929 at just one message for every six people.

0

1
1900

1910

1940

1930

1920

1950

Hours of work

1960

Minutes per person

1,000

350

100

280

Cost per 10-minute
international call

10

210

1

140
Minutes of
international calls

.1

The Telephone
International call volume languished for decades, despite a
long-term decline in the real cost
of service. Growth began to take
off only in the past two decades as
the toll became nearly negligible.

70

.01

0
1944

1934

1954

1974

1964

1984

1994

2004

Total e-mails sent (trillions)
12

The Internet
E-mailing is cheap—whether
messaging someone in town or
Timbuktu. The number of messages, even excluding spam and
advertising, has surged as more
people have become connected
around the world.

10

8

6

4

2

0
1995

1996

1997

1998

1999

2000

Federal Reserve Bank of Dallas

2001

2002

2003

2004



2005

2006

2006 Annual Report

just as they did for telegraph service. A 10-minute international
call fell from the equivalent of 844
hours’ pay in 1934 to 10 hours’ pay
in 1968 and one hour’s in 1990. The
steep decline didn’t spur a boom in
international communications. In
the past decade and a half, however, U.S. rates have dropped 95
percent, reaching just three minutes’ work time in 2006. Over this
period, annual international call
volume skyrocketed as the service
finally became cheap enough for
the masses. Use jumped from a half
hour per person in 1987 to almost
five hours today, an increase twice
as large as what occurred in the 70
years after the start of transatlantic
service in 1927.
Today, communication is
omni­present, fast and cheap. The
world is better connected than
ever, with 22 landlines and 42 cell
phones for every 100 people. The
Internet has emerged as a virtual

global village. A total of 209 nations are now online, up from just
20 in 1990. A sixth of the world’s
population has regular Internet
access, and cybercafes cater to
millions more.
Spiderwebs of fiber-optic
cables give us the bandwidth to
move massive amounts of information nearly anywhere in a
heartbeat. Today, the world has
217 million broadband subscribers, with Internet connections capable of transferring the equivalent of 6,100 pages a second. It
took 30 minutes to send the same
pages at the standard modem
speed in 1997.
The sharp decline in computer
communication costs has spurred
a rapid expansion in traffic. The
Internet and e-mail—part of
our lives for only 15 years—have
spread quickly. We maintained
1.4 billion e-mail accounts in
2006. Worldwide business and

2006 Annual Report



personal e-mail traffic jumped
from 18 per capita in 1995 to
nearly 1,500 in 2006.
Additional barriers to connectivity will crumble if countries and donors buy into MIT
professor Nick Negroponte’s
$100 laptop, which incorporates
a hand-cranked generator and
Wi-Fi transmitter. The device
aims at nothing less than bringing the world’s knowledge to
bright minds wherever they may
be—even among the most isolated students.
In just a few years, digital
communications have done for
information what transportation
technology did for goods. In
1956, a North Carolina trucking
company owner named Malcolm
McLean introduced con­tain­­erized ship­­ping, featuring 40-foot
steel boxes that could be lifted
from ships to trucks or trains
without repacking.
In the decades that followed,
huge container-shipping companies from the U.S., Taiwan,
Denmark, South Korea and elsewhere vied for cargo, helping
cut real ad valorem global ocean
freight rates by 40 percent since
the early 1970s. (See Exhibit 4.)
Efficiency gains have been
impressive in ground shipping,
but they’ve been even greater
in air cargo, especially over longer distances. In 1970, doubling
airfreight distance would have
increased shipping costs by 43
percent. Today, sending air cargo
twice as far raises prices only 16
percent.
Brainpower and communications mark our modern economy.
The more we know, the more we
communicate, the more we can
gain from globalization.

Federal Reserve Bank of Dallas

Tallying the Benefits
of Global Markets
Declining
communication
and transportation costs directly
reduce what consumers and businesses pay for a wide range of
goods and services. Telephone
calls can be had for pennies.
Information has become dirt
cheap. Every trip to the grocery
store or mall provides evidence
of the imported bargains in electronics, clothing and other goods.
But the gains don’t stop there.
Paying less to move information and goods sends ripples
throughout the world economy,
raising productivity and cutting
costs in numerous other ways.
Exhibit 4

Better Production Functions
In a more integrated global
economy, capital, labor and technology are freer to combine in
new and more efficient ways.
Companies can use the entire
world to carry out their production processes, realizing significant cost savings that can be
passed on to consumers.
The Industrial Age limited
companies’ efficiency. As long as
raw materials had to be trucked
in and workers had to be on site,
production functions rarely extended beyond a region or crossed
national borders. The decline in
shipping costs—particularly airfreight, with its fast delivery—allowed producers to broaden their

range of physical inputs. In a similar way, cheaper communications
have given service companies incentives to globalize their information operations.
The advent of global supply
chains, knit together by modern information technology, has
stretched major retailers far beyond their home countries. J.C.
Penney Co., for example, has used
digital technologies to shrink its
product cycles for women’s fashions (see page 10).
U.S. and European retailers are becoming multinationals
that reap enormous efficiency
gains from extending production functions backward into
the supply chain and forward

Getting the Goods More Cheaply

The cost of moving cargo has declined steadily, both for ocean
shipping and airfreight, spurring global competition among
producers and helping make imports cheaper for consumers.

Cost as percentage of value shipped
14

12

10

Airfreight
8

Ocean freight
6

4
1974

1979

1984

1989

Federal Reserve Bank of Dallas

1994

1999

2004



2006 Annual Report

Globalization Hits the Catwalk
J.C. Penney’s global fashion operations were lean and mean—but that
was just a starting point for Peter McGrath.
The Plano, Texas-based retailer’s
top executive for procurement, McGrath wanted to get as close as possible to zero turnaround time. Doing
it meant squeezing weeks out of every step in the product cycle—from
researching fashion trends all the way
through the logistics pipeline.
The spur came from the industry
itself. Over the past 20 years, the lag
time from fashion show to store had
shrunk by more than half, putting retailers on an ever faster treadmill. “You
can go into a runway show and have
a designer interpreting the fashion on
a factory floor in China within three
hours,” says McGrath (below).
As recently as 10 years ago, retailers operated on 70-week product
cycles. More efficient overseas sourcing and new technologies helped
shorten this to 50 weeks. J.C. Penney
was stuck there at the end of 2005,
tethered to a step-by-step product

cycle that required approvals at every
juncture.
“We knew we couldn’t make the
sewing machines, boats and trucks
go any faster,” McGrath says. “But we
thought we might be able to make the
processes run concurrently.”
McGrath’s first step was tearing
down the walls between staffers who
spot trends and those who design
clothes. “Today, the trend team roots
through the information it gathers and
delivers it directly to design.”
Trend team members continue to
attend fashion shows and study store
windows, but subscription web sites
deliver Milan’s runway shows and Bergdorf Goodman’s Christmas windows in
real time.
Choosing a color scheme to weave
through the next few seasons had taken five months. A photospectrometer
now scans colors digitally and shoots
them around the world via the Internet,
saving four weeks.
“We used to send the palette to
the mills overseas, which would then
send swatches back to the States,” Mc-

2006 Annual Report

10

Grath says. “New technology allows us
to approve color swatches on site.”
Today’s high-resolution technology produces computer images so
precise that designers in Plano can determine whether a suit jacket would fall
better if the shoulder were adjusted a
hair. The ability to make initial alterations without setting foot outside the
office stripped two weeks from the
product cycle.
As for production, nothing short
of complete reengineering would do.
Agreements with mills and manufacturers were rewritten, and every approval
process was streamlined.
Using technology and know-how,
J.C. Penney squeezed new efficiencies
from a global production function. Today, the company’s maximum product
cycle is only 40 weeks. The pinnacle of
efficiency is reserved for the juniors collections, which can go from concept to
store in just 17 weeks.
Despite the big drop in cycle time,
McGrath isn’t satisfied. He’ll continue to
alter fashion ops to better fit the world’s
resources.

Federal Reserve Bank of Dallas

into the consumer market. They
buy what’s cheap in China, India,
Vietnam and elsewhere, so they
can sell for less in the United
States. At the same time, major
retailers like Wal-Mart Stores
Inc., Home Depot Inc. and
Starbucks Coffee Co. are crossing the Pacific, not only to source
product but also to compete in
China’s burgeoning consumer
market. They’re also eyeing India,
which just opened its retailing
sector to foreign participation.
Plenty of other companies
now operate on a global scale.
U.S. firms’ sales through foreign
affiliates exceed total U.S. exports by three to one. Offshore
investments encompass all phases
of business—manufacturing, IT,
customer service, R&D, business
processing, management and distribution. Even China, a hot spot
for foreign investment, sees its
companies adopting global strategies. Haier, the country’s leading
appliance maker, operates more
than a dozen overseas factories,
including a refrigerator plant in
Camden, S.C.
The Knowledge Economy
opens the way for more businesses to stretch beyond national
borders. With greater mobility
come new opportunities for companies to hone their competitive
edge by looking for efficiencies in
every corner of the world.
Stronger Competition
Consumers no longer have to
settle for what’s available in local markets—a blessing for them
but a challenge for producers.
Globalization means new competition can come from anywhere
in the world. Imports relative to
global household consumption
Federal Reserve Bank of Dallas

11

2006 Annual Report

have been rising for decades, going from less than 18 percent in
1965 to more than 42 percent today. (See Exhibit 5.) The growth
rate has accelerated in the past
decade as declining communications costs have brought new industries into the global competition arena.
Competition forces us to
become more and more producExhibit 5

tive—if necessary, by going back
to the drawing board in search of
better ways to deliver goods and
services at lower prices. This simple dynamic, working on a global
scale, lies behind many U.S. companies’ oft-heard lament: We have
no pricing power.
What confounds sellers often
benefits buyers. In the past decade, U.S. prices fell for TV sets,

toys, dishes, clothing and many
other products facing significant
import competition. Prices rose
for many products untouched by
globalization—cable TV, hospital
services, sports tickets, rent, car
repair and others. From 1987 to
2003, faster-grow­ing import-toproduction ratios wrung inflationary pressures from domestic
producer prices in a large range

Global Competition Lowers Inflation

More Sellers…

Percent

World imports relative to consumption have doubled over the
past four decades, making more
of what consumers buy subject to
the broadening competition inherent in international trade.

45

40

35

30
World imports relative to
household consumption

25

20

15
1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2003

Average relative producer price inflation
(annual percentage change)
2

…Means Tamer Prices
Where markets become more
open, the added competition
tends to hold down the cost of
goods and services.

Real estate and other
business activities

Refined
petroleum

Hotels and restaurants

Transport
Finance

.5

Other transport equipment

0
Other manufacturing

Leather

–.5

Wood
Food

Basic metals

1

Publishing

Fabricated
metals Minerals

Trade Machinery
Paper
Vehicles
services

1.5

Textiles

–1

Plastics
Chemicals

Trend Line

–1.5
–2
–2.5

Telecommunications

Electrical and
optical equipment

–3
–3.5
–4

–3

–2

–1

0

1

2

3

4

5

6

7

8

Average growth in trade openness (annual percentage change)

2006 Annual Report

12

Federal Reserve Bank of Dallas

9

of industries. (See Exhibit 5.) The
gains from global markets aren’t
limited to goods traded internationally. They extend to such nontraded goods as houses, which
contain carpeting, wiring and
other inputs now facing greater
international competition.
Industrial Age globalization
largely involved goods, which
were usually heavy, bulky and expensive to move from one place
to another. The creation of worldwide markets for food, energy,
metals, vehicles, electronics, textiles and other products raised
living standards around the world
by increasing output, lowering
costs, boosting incomes and spurring economic progress.
Raw materials and manufactured products still make up the
bulk of today’s trade, with merchandise exports at record highs.
The globalization of goods
has meant more competition for
U.S. manufacturers. They’ve been
forced to close plants and trim
payrolls, of course, but they’ve also
become more productive. Since
1990, real factory output per U.S.
worker has risen from $52,000 to
$108,000.

While Industrial Age globalization increased competition
among goods producers, service
providers largely remained insulated in their home markets.
Transportation costs fell, but In­
dustrial Age communications remained expensive, limiting trade
in services and keeping their
prices high.
Services have become by far
the largest part of modern economies’ production—77 percent in
the U.S. and 66 percent in the
rest of the world. The Knowledge
Economy’s rapid, cheap communications have sparked a new
round of globalization, this one
increasing competition for services as well as goods.
The ratio of services to goods
in U.S. exports now stands at 44
percent, up from about 25 percent a quarter century ago. (See
Exhibit 6 on page 14.) Growth
in services trade has been slower
for the world as a whole, climbing from 21 percent to 25 percent of goods exports since 1975.
The numbers suggest the United
States is ahead of other nations
in shifting output from goodsproducing industries to services.

Federal Reserve Bank of Dallas

13

In coming years, other countries
will likely follow the U.S. lead in
increasing services trade.
While total U.S. services exports rose a bit faster than goods
from 1992 to 2005, many individual sectors have been moving faster in penetrating overseas markets. Eleven categories
post­ed increases of better than
10 percent a year—among them,
computer and information services; film and television rentals;
research and testing; accounting, auditing and bookkeeping; finance; and education. Just
five import categories, however,
showed gains of at least 10 percent a year—industrial engineering, finance, operational leasing,
insurance, and sports and performing arts. (See Exhibit 6.)
Overall, the U.S. runs a surplus in services trade—a reflection of its prowess in many of
the Knowledge Economy’s highvalue-added sectors.
Resource endowments and
talents often lead nations to

2006 Annual Report

Exhibit 6

At Your Service

Sector Climbs as Share of Exports

Ratio of services to goods trade
.45

The Knowledge Economy, with its freer flow of information, creates new competition as it expands
international trade in services. In the past two decades, exports of services have risen faster than
goods, particularly in the United States (right).

United States

.40
.35
.30
World

Industry Trade Patterns Shift

.25

From 1992 to 2005, U.S. exports rose by at least
10 percent a year in 11 industries (below). Imports
have increased that much in only five industries.

.20
.15
1975

1980

1985

1990

1995

2000

2005

Exports

Operational leasing
Telecommunications
Sports and performing arts
Industrial engineering
Medical services
Travel
Advertising
Passenger fares
Legal services
Royalties and license fees
Education
Installation, maintenance and repair of equipment
Training services
Financial services
Insurance services
Management and consulting services
Accounting, auditing and bookkeeping services
Research and development and testing services
Film and television tape rentals
Computer and information services
All services
All goods
–10

–5

0

–5

0

5
10
Real growth (annual percentage change)

15

20

25

15

20

25

Imports

Passenger fares
Travel
Telecommunications
Advertising
Research and development and testing services
Installation, maintenance and repair of equipment
Accounting, auditing and bookkeeping services
Education
Training services
Royalties and license fees
Medical services
Management and consulting services
Legal services
Film and television tape rentals
Computer and information services
Sports and performing arts
Insurance services
Operational leasing
Financial services
Industrial engineering
All services
All goods
–10

2006 Annual Report

5
10
Real growth (annual percentage change)

14

Federal Reserve Bank of Dallas

concentrate on one industry segment or another. Sometimes,
though, countries appear to be
selling each other the same things.
Computer and information
services, for example, led U.S. export growth at 22 percent a year
from 1992 to 2005, but the sector’s import growth was strong,
too, at 10 percent. Nations may
indeed exchange similar services,
but further analysis reveals trade
patterns based on comparative
advantage. In computer services,
the U.S. exports the highly valued
knowledge of researchers, systems architects and designers. It
imports the services of basic programmers—the foot soldiers in
the information economy.
In the Knowledge Economy,
service companies and workers
are learning what goods producers
have long known: Globalization
creates opportunities but also
causes hardships. Some firms
will prosper; others will go out of
business. Inevitably, workers will
lose their jobs and face the challenge of finding new ones. Global
markets may make more of us
vulnerable in terms of job security,
but we all benefit because worldwide competition brings lower
prices—for consumer goods, for
producers’ inputs and, now more
than ever, for services.
Greater Specialization
The crosscurrents in services
trade show that global markets
expand the scope for specialization. We do what we do best and
trade for the rest. For an economy
as a whole, specialization leads to
productivity gains beyond what
firms can achieve at the microeconomic level through new
technologies and investments in

plants and equipment. Indeed,
one of globalization’s greatest
benefits lies in its incentives to
reorganize economic activity and
reallocate global resources to yield
greater output.
Even when communications
costs were high, globalization created opportunities for vertical integration in manufacturing, with
an international division of labor
based on natural resources and
other inputs. A textbook example,
popularized by Milton Friedman,
is the ordinary wooden pencil—
made with cedar from Oregon,
graphite from Ceylon, brass from
U.S. smelters and eraser components from Indonesia.
Today’s world shifts the focus to human resources, forging
a somewhat different division of
labor. The U.S. and other wealthy,
well-educated nations supply the
world with goods and services
steeped in knowledge. Highly
skilled workers in these countries
produce jet aircraft, pharmaceuticals, cutting-edge electronics
and all sorts of high-value-added
goods. At the same time, managers, lawyers, entertainers and
other knowledge workers have
more opportunities to apply their
talents on a global scale. U.S. pro-

Federal Reserve Bank of Dallas

15

fessors, for example, no longer
teach students only on campus.
With today’s advanced communications, they can gather students
in Europe, Asia and the Americas
into virtual classrooms.
The all-American Barbie doll
illustrates how a globalized economy comes together to lower
costs. A 1990s study reported
that the dolls were made with
plastic from Taiwan, nylon hair
from Japan and cloth from China,
with final assembly in Indonesia
and Malaysia. Design, marketing
and distribution—the high-valueadded service components of the
production process—took place
in the United States. Including
profit, 80 percent of Barbie’s selling price stayed in the U.S.
In addition to manufacturing,
developing nations are finding
niches in service industries. India’s
doctors perform hip replacements
and other surgical procedures at
lower prices than U.S. hospitals.
Outsourcing of business services
has grown rapidly, with companies in wealthy nations pursuing
service-sector vertical integration
by shipping call centers, data processing and other routine tasks to
workers in India, the Philippines
and other emerging economies.

2006 Annual Report

Larger Market Size
The telephone wouldn’t have
been worth much had Alexander
Graham Bell lived on an island of
a dozen people, all within shouting distance. It takes large numbers of customers separated by
vast distances to make telephone
services profitable.
For many goods and services,
market size matters—a lot. In addition to their role in widening
the search for inputs and human
talents, larger markets provide
added impetus for innovation,
business formation and risk taking. Expanding the potential
customer base also helps create
viable markets for highly speExhibit 7

cialized products. Houston-based
Encysive Pharmaceuticals, for example, is looking to a global market to make its new treatment for
a rare lung condition pay off (see
page 17).
Industrial Age tycoons built
their fortunes largely from domestic sales. Among the 30 richest Americans in 1918: John D.
Rockefeller in oil, Henry Ford
in automobiles, J. P. Morgan in
banking, Andrew Carnegie in
steel, W. K. Vanderbilt and E. H.
Harriman in railroads, and J.
Ogden Armour and Louis F.
Swift in meatpacking. Indus­
trialists in Britain, Germany and
other nations rose to supply oil,

Roll It—All Around the World

U.S. sales for eight (in red) of the 15 biggest-budget movies weren’t
enough to cover the tab, yet all made handsome profits once the global
till finished ringing.
Millions of U.S. Dollars
15 Biggest-Budget Movies
King Kong (2005)

Budget

U.S. Sales World Sales

$207

$218

$549

Superman Returns (2006)

204

200

391

Spider-Man 2 (2004)

200

374

784

Titanic (1997)

200

601

1,835

Chronicles of Narnia (2005)

180

292

749

Waterworld (1995)

175

88

255

Wild Wild West (1999)

175

114

218

Van Helsing (2004)

170

120

300

Terminator 3 (2003)

170

150

433

The Polar Express (2004)

170

173

297

Poseidon (2006)

160

61

182

Alexander (2004)

155

34

167

Pearl Harbor (2001)

152

199

451

Troy (2004)

150

133

497

Pirates of the Caribbean 2 (2006)

150

423

1,065

2006 Annual Report

16

cars, banking, steel, transport and
meat to their national markets.
Knowledge Age moguls are
global entrepreneurs. Forbes’ roster of the superrich is dominated
by business leaders who amassed
their fortunes with little regard for
borders. America’s Bill Gates built
the world’s largest software company. Sweden’s Ingvar Kamprad
sells Ikea furniture worldwide.
India’s Lakshmi Mittal produces
steel in 16 countries on four continents. France’s Bernard Arnault
markets luxury goods all over the
world under the Louis Vuitton,
Fendi and Christian Dior labels.
Bigger markets may even
make for better movies. More
than half the 15 biggest-budget
films in history failed to break
even in the U.S. Hollywood supplements the domestic market
with foreign sales, accounting for
more than half of some movies’
revenue. On a worldwide basis,
the top 15 made it into the black,
with the foreign take exceeding
domestic box office for all but
three films. (See Exhibit 7.)
If the business weren’t globalized, filmmakers might have had
to curtail spending, perhaps by
scaling down sets, doing less research, settling for cruder animation, or getting by with not-sospecial effects. The bottom-line
contribution from fans around
the world allows filmmakers to
make bigger-budget movies.
The U.S. economy is huge, accounting for a quarter of world
output. But simple math suggests
globalization quadruples the size
of American entrepreneurs’ playing field. The global market gives
them—and their competitors
around the world—history’s largest customer base.

Federal Reserve Bank of Dallas

New Hope for Fighting Disease
Pulmonary arterial hypertension, a
rare disorder involving extremely high
blood pressure in the lungs’ smallest
arteries, afflicts an estimated 100,000
people in the U.S.—a number too large
to ignore but too small to entice most
drug companies.
Going global proved the way
around this dilemma for Encysive Pharmaceuticals. By expanding the number
of potential patients, the international
market gave the Houston-based firm
the critical mass it needed for Thelin, its
brand name for sitaxentan sodium.
“If you are going to put in all the
effort to build out an infrastructure, you
really have to have enough patients to
make it worth your while,” says Encysive
president and CEO Bruce Given (below).
Pulmonary arterial hypertension
is one of 5,000 so-called orphan diseases, those afflicting fewer than 200,000
people in the U.S. The larger market size
inherent in globalization makes it far
more likely that companies will embark
upon the risky business of finding new

treatments. “There are some orphan indications so small that to attain enough
patients for regulatory filings, there
is no other choice than to go global,”
Given says.
Developing drugs is extremely
expensive. For every 1,000 that are synthesized, 100 go to animal testing, 10 to
clinical trials and only one makes it to
the marketplace. Without enough patients, pharmaceutical companies can’t
justify the time and expense needed for
research and the approval process.
Encysive is currently selling Thelin
in Europe and awaiting Food and Drug
Administration approval in the U.S. Approval is also pending in Canada and
Australia, and the company is casting
its eyes toward Latin America and perhaps beyond.
Going into Europe doubled the
potential market to 200,000 patients,
big enough to make Thelin a viable
drug. Encysive markets Thelin directly
in Europe and plans to do the same
in the United States and Canada. Else-

Federal Reserve Bank of Dallas

17

where, it will probably partner with a
big pharmaceutical company, which
will handle distribution and pay Encysive royalties.
“I don’t care who you are,” Given
says. “If you are in the business of developing a drug, you are doing so for
a worldwide market. Increasingly, this
includes looking for patients in places
like India and China, which was not often done in the past.”
Global markets will ease the way
for future generations of orphan drugs.
An increasingly integrated world economy may even become crucial to mainstream treatments.
“As regulatory authorities continue
to seek greater assurances that drugs
are safe and effective prior to approving them, patient numbers in dossiers
are generally increasing,” Given says. “As
such, even in larger indications, companies often find it necessary or advisable
to go global to enroll enough patients
in their trials to meet regulatory expectations in a reasonable period of time.”

2006 Annual Report

Extended Economies of Scale
Industrial Age factories usually operated with high fixed and
high variable costs. Production
became cheaper as companies
ramped up output—but only to
a point. After that, churning out
each unit became more expensive, and serving additional demand increased costs. Decreasing
returns to scale eventually led to
higher prices.
An information-based world
differs from a material one in that
more products have high fixed
and low marginal costs—that is,
they exhibit increasing returns to
scale. Knowledge Age products
often entail steep development

costs because they incorporate
large amounts of highly paid
brainpower. Once production is
up and running, though, the marginal cost of selling to additional
consumers is relatively low over a
long horizon.
Such products become cheap­er
when markets are large and global.
Developing the typical drug, for
example, requires years of research
and testing by scientists, doctors and other expensive talent.
Pharmaceutical companies then
pay lawyers and lobbyists to navigate an arduous approval process.
Add it all up and the average cost
of bringing a new drug to market
is $1 billion. Once in production,

2006 Annual Report

18

though, each pill costs mere pennies to make.
The economics explains why
pharmaceuticals have become
a highly globalized business.
Overseas sales account for more
than 40 percent of top U.S. drug
firms’ revenues, even though
they have a huge home market.
Companies in smaller countries
derive an even higher portion
of their sales from beyond their
borders.
Installing cellular telephone
infrastructure, like developing
new drugs, is costly. Over the
past two decades, wireless investment topped $200 billion in the
U.S. alone—high fixed costs, to
be sure. Increasing demand lowers cell phone prices because networks add customers at minimal
expense, spreading the fixed costs
over a vast number of consumers.
Once a luxury only the rich could
afford, service is now within reach
of the masses. More than 2.7 billion cell phones are in use worldwide, far surpassing the number
of wired connections.
Cell phones have become the
dominant form of communication in many developing countries, allowing even Guatemalan
shoeshine boys to get connected.
Indeed, at every level of economic
development, the cell phone industry’s increasing returns make
it easier for more people to afford
phone service. (See Exhibit 8.)
Landline phone service grew
into a mammoth industry long
before the microprocessor ushered in the era of cell phones.
Electricity, wires and a modicum of electronics were enough
to make “Mr. Watson, come
here …!”—with all that ensued.
Even the earliest cell phones,

Federal Reserve Bank of Dallas

(c) 2007 The Hunger Project, www.thp.org

however, embodied far greater
knowledge content—microchips
to control the signal, filter out
static, move callers from tower to
tower and store numbers.
Despite all the technology, cell
phones are cheaper than landlines
because their chief component is
the microchip, an input produced
with very high fixed and very low
marginal costs. Plunging prices
for computer chips have made
handsets more affordable. Texas
Instruments Inc., for example,
has developed a single microchip
that performs all the necessary
functions at a great savings in
production costs, allowing newer
models to sell for as little as $30
(see page 20).

A Cellular World

Exhibit 8

Wireless service has spread more rapidly than landline phones. Increasing returns to scale have rapidly reduced cell phone costs, allowing more users at all income levels to get connected.
Ownership per 100 people
140

I

H

120

E

Z

100

S
K

P

60

J

T
C B

40

R T
B

20

C

G

A = United States (America)
B = Brazil
C = Colombia
D = Denmark
E = Estonia
F = Finland
G = Germany
H = Hong Kong
I = Italy
J = Japan
K = Korea
M = Mexico
N= New Zealand
P = Poland
R = Russia
S = Spain
T = Turkey
U = United Kingdom
Z = Czech Republic

D

F

N

R

80

U

K

M
P

E

H
N

S

G

U
I

J

A
A

D

F

Z

M

0
$0

$10,000

$20,000

$30,000
GDP per capita
Cell phones

Federal Reserve Bank of Dallas

$40,000

$50,000

Landlines

19

2006 Annual Report

$60,000

Cell Phones for the Masses
The name says a lot: LoCosto. Texas Instruments Inc. picked that moniker
for the industry’s first single-microchip
cell phone modem, designed for lowcost handsets aimed at customers in
emerging economies.
The LoCosto chip (
actual size)
handles the cell phone functions that
once required three or four microprocessors. Yet it’s powerful enough to enable mobile phones to play music and
videos.
“You need to have a performanceto-price ratio that people can afford,”
says Remi El-Ouazzane, a French citizen
who’s general manager of the TI business unit that markets LoCosto.
Cell phones’ cost barriers have
been tumbling for decades. In the
1980s, the first models sold for more
than $4,000, well beyond the means
of all but the most affluent consumers.
The LoCosto chip will be a critical component in phones selling in developing
countries for $30 or less.
Cheaper cell phones have emerged
from a relentless drive to reduce the
number and cost of components. The

single-chip technology, developed in
2002 and used in Bluetooth, GPS devices, Wi-Fi and portable digital TVs,
allows TI to reap higher effective yields
from silicon wafers, the raw material for
microprocessors. By cutting the number of microprocessors, the LoCosto
chip reduces power consumption and
the circuit board’s size and cost.
Despite being key to low-priced
phones, the LoCosto chip is anything
but low tech. “We are using the most
complex and advanced technology to
address the needs of the less advanced
parts of the world,” El-Ouazzane says.
TI won’t divulge its costs, but ElOuazzane acknowledges that developing new technologies requires a lot
of research and development money,
which can only be recouped over long
production runs.
“Economies of scale are required
to sustain the R&D needed to develop
revolutionary architecture,” he says.
Because it targets emerging markets, the LoCosto chip is by its very
nature a global product, intended for
mass production. TI sold 15 million

2006 Annual Report

20

units in the six months after LoCosto’s
launch in September 2006—the fastest start ever for a wireless product at
TI, the No. 1 producer of chips for cell
phones.
Motorola, Nokia and China’s
original equipment manufacturers
are among the dozen handset makers already buying LoCosto chips. “The
emerging countries are becoming the
fastest-growing markets in the world
for all global companies,” El-Ouazzane
says. “The market for cell phones is untapped, whether it’s in India, China or
South America.”
Cell phones are pivotal for bridging the digital divide that separates rich
and poor countries. In many emerging
economies, a handset in the pocket or
purse may be many citizens’ primary
means of accessing information, including the Internet. None of it would
be possible without increasingly cheap
microprocessors, made possible by the
economies of scale wrought from global markets.

Federal Reserve Bank of Dallas

Software, computers and the
Internet also exhibit increasing
returns to scale. So do many products whose principal components
are microchips and software—
digital cameras, DVD players,
computer games, GPS devices
and MP3 players. Increasing returns find their way into traditional industries, too. Agricultural
research involves long and expensive scientific work on ways to
increase crop yields and prevent
plant diseases. The variable costs
of new seeds are usually low.
Broader Capital Markets
Goods and services aren’t
alone in moving more readily across borders. As barriers to
capital flows have fallen, investment money—the driving force
for economic growth—has been
freed to seek the highest returns
anywhere around the globe.
It has done so with a vengeance. Since 1980, accumulated
foreign investment in stocks and
bonds has risen from 1.5 percent
to 59 percent of world output.
Direct investment in overseas
companies has risen from 5.2
percent to 24 percent.
The money helps businesses
start or expand operations, invest in new equipment, acquire
state-of-the-art technology, and
undertake research and development projects. The result: Output
goes up; costs go down.
Rich countries still receive
the bulk of cross-border investment, but new players are emerging. China has been among the
leaders in receiving foreign plant
and equipment investment in
recent years. What’s more, the
country trailed only the United
States in initial public offerings

in 2005, with 15 percent of the
world total.
Financial integration has
given budding entrepreneurs in
many countries access to cheaper
capital. In effect, financial markets have been democratized,
spreading the available investment money to an ever-widening
population.

imposed barriers to entry or few
alternative products. Without
competitors to contest for consumers, producers had more
power to reap extra profits by
keeping prices high.
Globalization erodes market
power. Natural monopolies that
might rise in national economies—airlines, electricity or telephone service, for example—don’t
More-Contestable Markets
exist on a global scale.
The integration of world capMonopolies bedeviled Indus­
trial Age economies. Many of ital markets makes it more likely
them owed their existence to the competitors will enter highly
limits inherent in national mar- profitable markets. No finankets—a single producer able to cial hurdle is too high. A world
meet all demand, high costs that awash in money can supply any

Federal Reserve Bank of Dallas

21

2006 Annual Report

amount of up-front investment
needed to start new businesses
and challenge monopolists.
While economies of scale
in knowledge-based industries
may encourage large producers,
globalization has made markets
more contestable by promoting
freedom of entry and rival products. Simply put, there is no
monopoly on ideas. Software
developers can create alternative batches of code to program
computers. Microchip designers
can find new ways to increase the
product’s power.
The threat of new competition keeps prices low. Today’s
world economy, saturated with
knowledge more readily shared
across borders, will be quicker
to bring alternative products to
market, replacing monopolies
with competition.
Greater Knowledge Spillovers
Knowledge can be found in all
corners of the world—but it’s not
distributed equally. In the U.S.,
for example, more than 30 percent
of those age 25 and over are college graduates—tops in the world
by far. In an increasingly globalized world, knowledge produced
in one country rarely stays there
long. It readily flows to where it
has value. (See Exhibit 9.)
Intellectual property deserves
strong legal protection, but knowledge spillovers generate significant
benefits. They come in two broad
categories—those embodied in
goods, services and capital moving from one country to another,
and those that exist apart from
trade and investment.
Often not industry-specific,
disembodied knowledge can
great­ly expand countries’ capac-

ity to produce goods and services
for world markets. U.S. professors
W. Edwards Deming and J. M.
Juran developed techniques for
quality control that vastly improved manufacturing processes.
After embracing their approach
in the 1950s, Japan transformed
its war-ravaged economy into a
high-quality, low-cost manufacturing powerhouse. With Japan’s
success, the ideas gained currency
in the United States and many
other parts of the world.
A modern-day application of
disembodied knowledge can be
found in the Human Genome
Project. Scientists unlocked the
secrets of DNA in 2001, and al-

2006 Annual Report

22

ready it has led to new treatments
for disease. The genetic code has
been posted on the Internet, making this deep reservoir of medical
knowledge available to researchers around the world.
Disembodied knowledge goes
well beyond scholarly and scientific work. It includes financial
news, print and electronic media,
analytical reports, databases and
even gossip. This kind of knowledge moves between countries
when people migrate or travel and
when far-flung colleagues interact
via the Internet, e-mail and cell
phone. Students studying abroad
are particularly important in diffusing knowledge. Today, they’re

Federal Reserve Bank of Dallas

Brain Gain, Not Brain Drain

Exhibit 9

More Seek Knowledge Abroad…
Millions of foreign students
3

The number of students studying overseas more than quadrupled in the past
four decades (right). The U.S. led, with 22 percent of the foreign students in
2004.

U.S.
U.K.
Germany
France
Australia
Canada
Japan
New Zealand
Russia
Italy
Spain
Belgium
South Africa
Other

2.5

…but Educational Gaps Still Large
While the U.S. educates more foreigners than any other country, it still leads the
world by a large margin in college graduates as a share of its own adult population (below).

2

1.5

College graduates (percent)
35

1
U.S.
30

.5
South
Korea

25

20

Former
USSR
Peru
Japan Germany

15

U.K.

0

2004

1975

France
Mexico

10

Brazil
Indonesia

5

India

Sudan

China

Kenya
Congo DR

0
1,000

500

0

1,500

2,000

2,500

Population over age 25 (millions)

Percentage of the Highly Skilled
Population That’s Foreign Born
1995

2001

Austria

15.0

14.3

Belgium

9.7

10.1

Canada

19.8

25.8

Denmark

On the Move
In the past decade, more educated workers have crossed borders in
search of opportunities (left). Not long ago, many Chinese who studied
overseas stayed there. But now a fast-growing economy is luring them
home (below).

5.2

7.6

France

12.3

12.4

Greece

6.1

12.1

Ireland

11.3

18.1

30,000

.9

6.1

25,000

Luxembourg

40.1

49.0

Netherlands

8.8

8.8

Portugal

2.8

15.3

15,000

Spain

3.8

6.5

10,000

Sweden

8.2

14.2

5,000

8.8

16.0

11.5

14.5

Italy

United Kingdom
United States

Federal Reserve Bank of Dallas

More Chinese Students Returning Home

40,000
35,000

20,000

0

1978

1981

1984

23

1987

1990

1993

1996

2006 Annual Report

1999

2002

2005

doing so in record numbers, with
the U.S. the top destination.
An interconnected world
facilitates the transfer of disembodied knowledge across national boundaries. For example,
an Internet search led BrassCraft,
a valve manufacturer, to a company in a small European village,
the only source of the specialized
knowledge needed to automate
its operations (see page 25).
Knowledge workers have
more mobility today than they did
even a decade ago. (See Exhibit 9.)
A headlong rush toward a market
economy has made knowledge
worth more in China. As a result,
a growing number of Chinese
students educated in the U.S. and
elsewhere are returning home,
taking with them knowledge they
can use in their country’s fastmoving economic development.
Embodied knowledge spillovers proliferated in the Industrial
Age. Physical goods dominated
world trade and long-distance
communication was expensive.
We still see a lot of these spillovers, but today’s informationrich globalization creates far
greater opportunities for transferring know-how not internalized in goods and services.

Newly added TV viewers
don’t reduce the consumption of
those already tuned in. Oprah
Winfrey’s talk show broadcasts to
126 countries. She’s not alone. A
large and growing number of TV
channels are reaching global audiences. MTV, for example, was
seen in 496 million households in
2006. (See Exhibit 10.) As broadband Internet connections spread,
all forms of audio and video will
become truly global extensions of
nonrivalrous consumption.
Many people consuming simultaneously can even make for
a better product. The more households with phones, the greater
value in owning one. A bonus
from popular movies and TV

Spread of Nonrivalrous
Consumption
Most material goods are rivalrous. A shirt can be worn by
only one person at a time. A meal
can be eaten only once. However,
billions of people log on to the
Internet at the same time. One
person’s use doesn’t inhibit use by
someone else down the street or,
for that matter, in the deserts of
Mongolia. The Internet is nonrivalrous in consumption.
2006 Annual Report

Exhibit 10

shows lies in the added enjoyment of talking about them with
other viewers. From e-mail to
package delivery, networked services illustrate how nonrivalrous
consumption adds value.
The Industrial Age was one
of rivalrous goods. Supply was
limited, and increases in demand
tended to bid up prices. More of
today’s consumption is nonrivalrous, made possible by the technologies that disseminate information quickly and cheaply to
large audiences. When it comes
to knowledge products, supply
isn’t limited in the traditional
sense. An increase in demand
doesn’t necessarily raise prices. In
fact, it often lowers them.

On the Air, Everywhere

Television provides nonrivalrous consumption and faces few technological barriers to reaching a global audience.

MTV Networks
Discovery
Fox
CNBC
BBC World
A&E Networks
Bloomberg
CNN International
TV5 Monde (French)
0

100

200

300

400

Global distribution (millions of households)

24

Federal Reserve Bank of Dallas

500

Finding Technology in Faraway Places
Behind every sink and toilet, you’ll
find a water ball stop—a valve to turn
the water on and off. Traditional stops,
dating to the 1940s, require eight or
nine wrist-wrenching rotations.
­BrassCraft made this kind of stop
but figured a nice market could be built
for one that accomplished the task in a
quick quarter turn.
The company’s Lancaster, Texas,
plant produced traditional stops in
two 10-hour shifts. A semiautomated
process limited output per operator to
6,500 valves per shift.
“It was all about manual dexterity,
and the operator would go on autopilot pretty quickly,” says director of operations Jim Bevan (below).
Using the same technology to produce quarter-turn valves would require
too much handling to make operations

profitable. So BrassCraft faced the same
challenge as Henry Ford: How to mass
produce in the U.S. with lower labor input. The obvious solution was a higher
degree of automation, but the technology simply didn’t exist.
Or did it?
Don Glover, engineering vice president at BrassCraft’s Novi, Mich., headquarters, had heard of a European company that made equipment to produce
quarter-turn gas valves. Gregg Koehn,
director of manufacturing engineering,
scoured the Internet, finding his mark in
a small town he’d never even heard of.
In January 2002, Bevan and Koehn
took off on a quest key to their company’s future.
“What’s impressive about the
equipment we found is that they’ve
forgotten more than anyone’s ever

Federal Reserve Bank of Dallas

25

known about this type of assembly,”
Bevan says.
BrassCraft’s goal was technology
that could produce a ball stop valve
every three seconds, with operators
limited to troubleshooting. In the first
meeting, working through translators,
the equipment maker concluded that
it could build machines to make one
every 3.25 seconds. The European company vowed to find a way to squeeze
out that quarter-second.
Seeing similar equipment in motion sealed the deal. Bevan and Koehn
observed a machine that turned out
valves with grand efficiency, controlled
by a single operator who only had to
touch every 100th piece.
Bevan had his nirvana moment. “It
was just beautiful to someone with an
engineering background,” he says. “Every single principle I had learned was
there in glorified form. The process was
quiet and precise.”
A custom-made machine arrived
at the Lancaster factory right on schedule, in November 2002. Three European
technicians spent three weeks installing it, sipping espresso on their breaks,
thanks to a machine BrassCraft bought
to help them feel at home.
In its first four years, the machine
has produced millions of valves. Productivity is up almost 700 percent—
and not one valve has been returned as
defective.
Globalization facilitates the kind
of knowledge spillovers that gave
BrassCraft a big productivity boost. As
ball stop valves keep coming off the
machine, BrassCraft continues to reap
the dividends of an integrated world
economy.

2006 Annual Report

Exhibit 11

A Guide to Globalization, Productivity and Cost

Globalization raises productivity and reduces cost in 10 ways.
Factor

How It Works

Lower Communication
and Transportation
Costs

Consumers benefit directly when moving information and goods across international
borders becomes cheaper. Communication and transportation drive the other factors in
this guide, offering even greater potential for higher productivity and lower costs.

Better Production
Functions

When communication and transportation are cheap and easy, firms have access to productive inputs anytime, anywhere. Firms can develop and manage production functions
less constrained by skills, work hours, cost and availability of local labor. They’re also less
reliant on local resources and capital.

Stronger Competition

Increased competition makes it harder for firms to raise prices when costs rise, forcing
managers to find better ways to produce. Those who do, survive; those who don’t are
eliminated. In this way, production is constantly transferred to the most efficient, adaptable and innovative firms.

Greater Specialization

People and nations become more efficient when they concentrate on what they do best
and meet other needs through trade. Output increases with equal or less labor input—a
pure productivity gain. Even better, specialization focuses attention on specific tasks,
leading us to think more deeply about how to improve production processes. What
stimulates innovation raises productivity growth.

Larger Market Size

The bigger the market, the greater the potential sales and profits. Market size stimulates
innovation and business formation by offering inventors, entrepreneurs and capitalists
greater return for their ideas, effort and risk.

Extended Economies
of Scale

Most knowledge-intensive goods are produced under conditions of high fixed and low
marginal costs, which create substantial economies of scale. Larger markets expand
producers’ reach, allowing them to spread the fixed costs over even more customers.
The results are lower unit costs of production and lower prices for consumers.

Broader Capital Markets

Access to global capital enables entrepreneurs to shift productive assets to uses with
the highest returns, wherever they may be.

More-Contestable
Markets

In a world of isolated nations, a supplier in a small country may have substantial monopoly power. Integrating economies puts producers everywhere in competition, with
access to a virtually limitless supply of capital. The threat of new entrants discourages
suppliers from charging too much.

Greater Knowledge
Spillovers

The transfer of productive knowledge makes economies more efficient. Knowledge
has long moved across borders through trade (embodied knowledge). Now, more of
the spillovers are general information and research (disembodied knowledge), creating
larger economic ripples.

Spread of Nonrivalrous
Consumption

Products are nonrivalrous when one person’s consumption doesn’t diminish another’s.
TV, movies and the Internet are examples of nonrivalrous goods that can serve additional customers without significant additional costs, thereby contributing to lower costs as
they speed around the globe.

2006 Annual Report

26

Federal Reserve Bank of Dallas

Living Standards
on the Rise
The world’s reservoir of knowledge has risen steadily in recent
decades. What’s more remarkable about our times, though, is
our instant access to knowledge
acquired anywhere on the planet.
The technologies that make it
cheaper to create, store, process
and move information bring
far-flung economies closer together—in a very real sense, making the world a smaller place.
Declining costs for moving
goods and information drive globalization itself and propel the
private sector to produce more at
lower costs. The economic forces
globalization unleashes are basic:
international production functions, competition, specialization,
larger markets, economies of scale,
capital flows, more-contestable
Exhibit 12

markets, knowledge spillovers
and nonrivalrous consumption.
(See Exhibit 11.)
While conceptually distinct, these forces feed into each
other in the real world, boosting
their power. Specialization, for
example, creates opportunities
to further extend economies of
scale. Knowledge spillovers hasten improvements in production
functions.
All told, the greater productivity from globalization reduces
costs and price pressures in the
Knowledge Economy, much as it
did in the Industrial Age. What’s
changed isn’t the nature of the
productivity push but its scope,
reaching more countries and affecting more industries.
The planet has been becoming
richer as a result. Global productivity growth has nearly doubled,
going from 1.2 percent a year in

the 1980s to 2.3 percent a year in
the past decade. Just as important,
gains have been widespread. All
regions except Western Europe
and Japan did better in the past
decade than they did in the 1980s.
(See Exhibit 12.) The faster rise in
productivity bodes well for both
living standards and the real cost
of living.
The Industrial Age delivered
huge gains in productivity, allowing more people to live better. The
Knowledge Economy promises
even greater progress. A technological revolution that makes access to information cheaper and
more democratic has sped up
globalization, spread its benefits
deeper into societies and touched
nearly every part of the world.
Knowledge is the ultimate source
of wealth. Through globalization,
we can spread its bounty.
— W. Michael Cox and Richard Alm

World Productivity Growth on the Rise

Fundamental economic forces have sped up productivity gains in nearly all parts of the world. Becoming more
efficient reduces costs. Just as important, it leads to higher living standards—the real gain from globalizing the
Knowledge Economy.
Annual productivity growth (percent)
8

1980–90

6

1995–2005

4

2

0

–2

China

India

Eastern
Europe

United
States

11.5

5.6

5.9

21.0

Western
Europe

Japan

Middle East
and Africa

Latin America
and Caribbean

Other

World

21.4

7.3

5.5

8.0

13.8

100

Share of world output (percent)

Federal Reserve Bank of Dallas

27

2006 Annual Report

Notes and Credits
Acknowledgments
“The Best of All Worlds” was written by W.
Michael Cox and Richard Alm. The essay
is based on research conducted by Cox,
senior vice president and chief economist,
Federal Reserve Bank of Dallas. Alm is
a senior economics writer in the Bank’s
Research Department. Julia K. Carter, a
senior economic analyst at the Bank, provided important research assistance on
the project. Danielle DiMartino, economics writer at the Bank, wrote the stories on
pages 10, 17 and 25.

Exhibit Notes and Data Sources
EXHIBIT 1
Robert J. Barro and Jong-Wha Lee (2000),
“International Data on Educational Attainment: Updates and Implications,” Working Paper no. 42, Center for International
Development, Harvard University, April.
Organization for Economic Cooperation
and Development (OECD), Education at a
Glance: OECD Indicators 2006.
OECD, Science, Technology and Industry
Outlook 2006.
National Science Foundation, Science and
Engineering Indicators 2006.
United Nations Educational, Scientific and
Cultural Organization, UNESCO Statistical
Yearbook 1998 and Global Education Digest
2006.

Peter Lyman and Hal R. Varian (2003),
“How Much Information?” School of
Information Management and Systems,
University of California at Berkeley.

OECD, Education at a Glance, 2006.
Robert Barro and Jong-Wha Lee (2000).

Bureau of Economic Analysis (BEA), national economic accounts, fixed assets.

OECD, Science, Technology and Industry
Outlook 2006.

Wikipedia, www.wikipedia.org.

Chinese Ministry of Education.

EXHIBIT 2
Wikipedia.

EXHIBIT 10
Viacom, www.viacom.com.

EXHIBIT 3
Historical Statistics of the United States:
Millennial Edition Online, Cambridge
University Press.

Discovery Networks International, http://
corporate.discovery.com.

Federal Communications Commission,
Trends in the International Telecommunications Industry 1998 and 2005.

EXHIBIT 4
David L. Hummels (forthcoming), “Trans­
portation Costs and International Trade in
the Second Era of Globalization,” Journal
of Economic Perspectives.

World Intellectual Property Organization,
statistics on patents.

World Bank, World Development Indicators database.

National Human Genome Research Institute, http://genome.gov.

International Monetary Fund, World
Economic Outlook, April 2006.

International Telecommunication Union
(ITU), World Telecommunication Development Report 2003 and World Telecommunication Indicators database.

EXHIBIT 6
World Bank, World Development Indicators database.

A&E Television Networks, www.
aetninternational.com.
Bloomberg, http://about.bloomberg.com.
London Business School Media Club,
www.londonmediaclub.org/summit/
sponsors.html.

EXHIBIT 12
World Bank, World Development Indicators database.
Photo Credits
(c) 2007 Intuitive Surgical Inc., p. 4.
(c) 2007 Chuck Kuhn, p. 8.
Columbus Regional Airport Authority, p. 9.
J.C. Penney Co., p. 10.
Preben Bailey, International Shopfitting
Organisation, Sweden, p. 11.

EXHIBIT 7
Nash Information Services, www.
the-numbers.com, movie budget records.

28

CNBC, www.cnbc.com.

TV5 Monde, http://tv5.org.

BEA, national and international economic
accounts.

2006 Annual Report

News Corp., Fox International Channels,
www.newscorp.com.

BBC World, www.bbcworldwide.com.

International Data Corp. (unpublished
data).

National Institute for Research Advancement, NIRA’s World Directory of Think Tanks
2002, www.nira.go.jp/ice/nwdtt/2005/intro/intro2002.html.

Thomas M. Lenard and Daniel B. Britton
(2006), The Progress & Freedom Founda-

EXHIBIT 9
The chart illustrating educational gaps
covers only countries with populations
that exceed 30 million.

Semiconductor Industry Association,
Global Billings Report History.

EXHIBIT 5
Inflation and trade openness data are for
1987–2003. The horizontal axis measures
the growth in a sector’s import-to-production ratio. The vertical axis measures
the inflation in a sector’s producer prices
relative to the economywide average.

World Bank, World Development Indicators database.

EXHIBIT 8
ITU, Information and Communication
Technology statistics database (ICT Eye).

tion, The Digital Economy Fact Book, 8th
edition.

Encysive Pharmaceuticals Inc., p. 17.
Courtesy of Texas Instruments Inc., p. 20.
National Human Genome Research Institute, p. 22.

Federal Reserve Bank of Dallas

Senior Management

Richard W. Fisher
President and Chief
Executive Officer

Helen E. Holcomb
First Vice President and
Chief Operating Officer

Harvey Rosenblum
Executive Vice President
and Director of Research

Meredith N. Black
Senior Vice President

W. Michael Cox
Senior Vice President and
Chief Economist

D. Karen Diaz
Acting Branch Manager and
Assistant Vice President,
San Antonio Branch

J. Tyrone Gholson
Senior Vice President

Robert W. Gilmer
Vice President in Charge,
El Paso Branch

Robert D. Hankins
Senior Vice President

Joanna O. Kolson
Senior Vice President

Robert Smith III
Senior Vice President in
Charge, Houston Branch

Millard E. Sweatt
Senior Vice President,
General Counsel,
Ethics Officer and Secretary

Federal Reserve Bank of Dallas

29

2006 Annual Report

Boards of Directors
Dallas

James B. Bexley
Associate Professor of
Finance, Sam Houston
State University

Ray L. Hunt
(Chairman)
Chairman, President and
CEO, Hunt Consolidated Inc.

Anthony R. Chase
(Deputy Chairman)
Chairman and CEO,
ChaseCom LP

Judy Ley Allen
Partner, Allen Investments

David S. Barnard
Chairman and CEO,
The National Banks of
Central Texas

Matthew T. Doyle
Vice Chairman and CEO,
Texas First Bank

Robert A. Estrada
Chairman and CEO,
Estrada Hinojosa and Co.

Richard W. Evans Jr.
Chairman and CEO,
Cullen/Frost Bankers Inc.

James T. Hackett
Chairman, President
and CEO, Anadarko
Petroleum Corp.

Ron C. Helm
(Chairman)
Owner, Helm Land and
Cattle Co.

Cecilia O. Levine
(Chairman Pro Tem)
President, MFI International
Manufacturing LLC

Pete Cook
President and CEO,
First National Bank
of Alamogordo

Fred Loya
Chairman, Fred Loya
Insurance Agency LP

Gerald J. Rubin
Chairman, President and
CEO, Helen of Troy Ltd.

F. James Volk
Regional President,
State National Bank

El Paso

William V. Flores
Executive Vice President
and Provost, New Mexico
State University

2006 Annual Report

30

Federal Reserve Bank of Dallas

Houston

Lupe Fraga
(Chairman)
Chairman and CEO,
Tejas Office Products Inc.

Nancy T. Chang
(Chairman Pro Tem)
Chairman of the Board,
Tanox Inc.

Timothy N. Bryan
Chairman and CEO,
The First National Bank
of Bryan

Douglas L. Foshee
President, CEO and
Director, El Paso Corp.

Jodie L. Jiles
Managing Director,
RBC Capital Markets

S. Reed Morian
Chairman, CEO and
President, DX Service
Company Inc.

Peter G. Traber
President and CEO, Baylor
College of Medicine

San Antonio

Elizabeth Chu Richter
(Chairman)
Chairman and CEO,
Richter Architects

J. Dan Bates
(Chairman Pro Tem)
President, Southwest
Research Institute

Matt F. Gorges
Chairman and CEO,
Valley International Cold
Storage Inc.

Ricardo Romo
President, University of
Texas at San Antonio

G.P. Singh
Chairman and CEO,
Karta Technologies Inc.

Guillermo F. Trevino
Vice President, Southern
Distributing

Federal Reserve Bank of Dallas

31

Steven R. Vandegrift
Founder and President,
SRV Holdings

2006 Annual Report

Officers

Small Business
and Agriculture
Advisory Council

Federal Reserve Bank of Dallas
Dallas

Harvey R. Mitchell III
Vice President

E. Ann Worthy
Assistant Vice President

Richard W. Fisher
President and CEO

William C. Morse Jr.
Vice President

Margaret C. Schieffer
Automation Officer

Helen E. Holcomb
First Vice President and COO

Sharon A. Sweeney
Vice President, Associate
General Counsel and
Associate Secretary

William W. Shaffer Jr.
Information Technology Officer

Harvey Rosenblum
Executive Vice President and
Director of Research
Meredith N. Black
Senior Vice President
W. Michael Cox
Senior Vice President and
Chief Economist
J. Tyrone Gholson
Senior Vice President
Robert D. Hankins
Senior Vice President

W. Arthur Tribble
Vice President
Mark A. Wynne
Vice President and Senior
Economist

Tommy E. Alsbrooks
Assistant Vice President

Houston

Jeffery W. Gunther
Assistant Vice President

Earl Anderson
Vice President

Diane M. Holloway
Assistant Vice President

Gloria V. Brown
Vice President
John V. Duca
Vice President and Senior
Economist

Sherry M. Kidd
Assistant Vice President
Alfreda B. Norman
Assistant Vice President

Robert G. Feil
Vice President

Dean A. Pankonien
Assistant Vice President

KaSandra Goulding
Vice President

John R. Phillips
Assistant Vice President

William C. Gruben
Vice President and Senior
Economist

Lawrence G. Rex
Assistant Vice President

Donald L. Jackson
Vice President

Robert W. Gilmer
Vice President in Charge
Javier R. Jimenez
Assistant Vice President

Stephen P. A. Brown
Assistant Vice President and
Senior Economist

Millard E. Sweatt
Senior Vice President,
General Counsel, Ethics
Officer and Secretary

El Paso

Mine K. Yücel
Vice President and Senior
Economist

Stephan D. Booker
Assistant Vice President

Joanna O. Kolson
Senior Vice President

Robert L. Triplett III
Information Technology Officer

Victor A. Schreck
Assistant Vice President

Robert Smith III
Senior Vice President in Charge
René G. Gonzales
Vice President
Luther E. Richards
Vice President
Donald N. Bowers II
Assistant Vice President
Daron D. Peschel
Assistant Vice President

Johnny N. Cavazos
Owner and Manager
Cavazos Insurance Agency
Brownsville, Texas
François L. Chandou
President
La Cave Warehouse
Dallas
Hattie Hill
Chief Executive Officer
Hattie Hill Enterprises Inc.
Dallas
Jason M. King
Manager and Owner
J. King Family Ranch LLC
Chappell Hill, Texas
Gregory J. Rohan
President
Heritage Galleries &
Auctioneers Inc.
Dallas

Federal Advisory
Council Member
James D. Goudge
Chairman and CEO
Broadway National Bank
San Antonio, Texas

Randy L. Steinley
Examining Officer

San Antonio
D. Karen Diaz
Acting Branch Manager and
Assistant Vice President
Richard A. Gutierrez
Assistant Vice President
As of December 31, 2006

Gayle Teague
Assistant Vice President

Kathy K. Johnsrud
Vice President
Evan F. Koenig
Vice President and Senior
Economist
Kenneth V. McKee
Vice President and General
Auditor

Michael N. Turner
Assistant Vice President
Marion E. White
Assistant Vice President
Bob W. Williams
Assistant Vice President

2006 Annual Report

32

Federal Reserve Bank of Dallas

MANAGEMENT’S REPORT ON INTERNAL
CONTROL OVER FINANCIAL REPORTING
March 5, 2007
To the Board of Directors of the
Federal Reserve Bank of Dallas:
The management of the Federal Reserve Bank of Dallas (“FRBD”) is responsible for the preparation
and fair presentation of the Statement of Financial Condition, Statement of Income, and Statement
of Changes in Capital as of December 31, 2006 (the “Financial Statements”). The Financial
Statements have been prepared in conformity with the accounting principles, policies, and practices established by the Board of Governors of the Federal Reserve System and as set forth in the
Financial Accounting Manual for Federal Reserve Banks (“Manual”), and as such, include amounts,
some of which are based on management judgments and estimates. To our knowledge, the
Financial Statements are, in all material respects, fairly presented in conformity with the accounting
principles, policies, and practices documented in the Manual and include all disclosures necessary
for such fair presentation.
The management of the FRBD is responsible for establishing and maintaining effective internal
control over financial reporting as it relates to the Financial Statements. Such internal control is
designed to provide reasonable assurance to management and to the Board of Directors regarding the preparation of the Financial Statements in accordance with the Manual. Internal control
contains self-monitoring mechanisms, including, but not limited to, divisions of responsibility and
a code of conduct. Once identified, any material deficiencies in internal control are reported to
management and appropriate corrective measures are implemented.
Even effective internal control, no matter how well designed, has inherent limitations, including the
possibility of human error, and therefore can provide only reasonable assurance with respect to the
preparation of reliable financial statements. Also, projections of any evaluation of effectiveness to
future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The management of the FRBD assessed its internal control over financial reporting reflected in
the Financial Statements, based upon the criteria established in the Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on this assessment, we believe that the FRBD maintained effective internal control over
financial reporting as it relates to the Financial Statements.
Management’s assessment of the effectiveness of the FRBD’s internal control over financial reporting as of December 31, 2006, is being audited by PricewaterhouseCoopers LLP, the independent
registered public accounting firm which also is auditing the FRBD’s Financial Statements.
Federal Reserve Bank of Dallas

President

Federal Reserve Bank of Dallas

First Vice President

33

Principal Financial Officer

2006 Annual Report

REPORT OF INDEPENDENT AUDITORS

To the Board of Governors of the Federal
Reserve System and the Board of Directors
of the Federal Reserve Bank of Dallas:
We have completed an integrated audit of the Federal Reserve Bank of Dallas’ 2006 financial statements, and of its internal control over financial reporting as of December 31, 2006, and an audit
of its 2005 financial statements in accordance with the generally accepted auditing standards as
established by the Auditing Standards Board (United States) and in accordance with the auditing
standards of the Public Company Accounting Oversight Board (United States). Our opinions, based
on our audits, are presented below.
Financial statements
We have audited the accompanying statements of condition of the Federal Reserve Bank of Dallas
(the “Bank”) as of December 31, 2006 and 2005, and the related statements of income and
changes in capital for the years then ended, which have been prepared in conformity with the
accounting principles, policies, and practices established by the Board of Governors of the Federal
Reserve System. These financial statements are the responsibility of the Bank’s management. Our
responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards as established
by the Auditing Standards Board (United States) and in accordance with the auditing standards of
the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 3, these financial statements were prepared in conformity with the accounting principles, policies, and practices established by the Board of Governors of the Federal Reserve
System. These principles, policies, and practices, which were designed to meet the specialized
accounting and reporting needs of the Federal Reserve System, are set forth in the Financial
Accounting Manual for Federal Reserve Banks, which is a comprehensive basis of accounting other
than accounting principles generally accepted in the United States of America.
In our opinion, the financial statements referred to above present fairly, in all material respects,
the financial position of the Bank as of December 31, 2006 and 2005, and results of its operations
for the years then ended, on the basis of accounting described in Note 3.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in the accompanying Management’s
report on Internal Control Over Financial Reporting, that the Bank maintained effective internal

2006 Annual Report

34

Federal Reserve Bank of Dallas

REPORT OF INDEPENDENT AUDITORS (continued)
control over financial reporting as of December 31, 2006, based on criteria established in Internal
Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria.
Furthermore, in our opinion, the Bank maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal
Control – Integrated Framework issued by the COSO. The Bank’s management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on
management’s assessment and on the effectiveness of the Bank’s internal control over financial
reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with generally accepted auditing standards as established by the Auditing
Standards Board (United States) and in accordance with the auditing standards of the Public
Company Accounting Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting,
evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the
circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting principles. A company’s
internal control over financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions
and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being
made only in accordance with authorizations of management and directors of the company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.

March 12, 2007

Federal Reserve Bank of Dallas

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2006 Annual Report

Statements of Condition (in millions)
December 31, 2006

December 31, 2005

Assets
Gold certificates

$

Special drawing rights certificates

575

$

549

98

Coin

98

81

67

348

535

Loans to depository institutions

—

3

U.S. government securities, net

35,168

36,949

Investments denominated in foreign currencies

236

217

Accrued interest receivable

302

287

3,537

—

294

297

Items in process of collection

Interdistrict settlement account
Bank premises and equipment, net
Other assets
Total assets

25
___________

29
___________

$ 40,664
___________
___________

$ 39,031
___________
___________

$

37,759

$ 33,311

1,329

1,502

704

811

1

1

306

303

37

31

—

2,693

91

58

Liabilities and Capital
Liabilities
Federal Reserve notes outstanding, net
Securities sold under agreements to repurchase
Deposits:
Depository institutions
Other deposits
Deferred credit items
Interest on Federal Reserve notes due U.S. Treasury
Interdistrict settlement account
Accrued benefit costs
Other liabilities
Total liabilities

13
___________

15
___________

40,240
___________

38,725
___________

Capital
Capital paid-in

212

153

Surplus (including accumulated other comprehensive
     loss of $28 million at December 31, 2006)

212

153

___________

___________

Total capital

424
___________

306
___________

Total liabilities and capital

$ 40,664
___________
___________

$ 39,031
___________
___________

The accompanying notes are an integral part
of these financial statements.

2006 Annual Report

36

Federal Reserve Bank of Dallas

Statements of Income (in millions)
For the Years Ended
December 31, 2006

December 31, 2005

Interest Income
Interest on U.S. government securities

$

Interest on investments denominated in foreign currencies

4
___________

3
___________

1,625

1,363

61
___________

39
___________

1,564
___________

1,324
___________

Compensation received for services provided

60

49

Reimbursable services to government agencies

14

11

Foreign currency gains (losses), net

14

(32)

3
___________

4
___________

91
___________

32
___________

112

101

Occupancy expense

20

20

Equipment expense

12

11

Assessments by the Board of Governors

29

33

59
___________

51
___________

232
___________

216
___________

$
1,423
___________
___________

$
1,140
___________
___________

$

$

Total interest income

1,621

$

1,360

interest expense
Interest expense on securities sold under agreements to repurchase
Net interest income
Other operating income

Other income
Total other operating income

Operating expenses
Salaries and other benefits

Other expenses
Total operating expenses
Net income prior to distribution

Distribution of net income
Dividends paid to member banks
Transferred to surplus
Payments to U.S. Treasury as interest on Federal Reserve notes
Total distribution

12

18

1,324
___________

1,113
___________

$
1,423
___________
___________

$
1,140
___________
___________

The accompanying notes are an integral part
of these financial statements.

Federal Reserve Bank of Dallas

37

9

87

2006 Annual Report

Statements of Changes in Capital
for the Years Ended December 31, 2006,
and December 31, 2005
(in millions)
		

Surplus

			
Capital
Net Income
Paid-In
Retained
Balance at January 1, 2005
(2.7 million shares)
Net change in capital stock issued
   ( 0.4 million shares)
    Transferred to surplus
Balance at December 31, 2005
(3.1 million shares)
Net change in capital stock issued
   (1.1 million shares)
Transferred to surplus

$ 135

$ 135

Accumulated
Other
Comprehensive
Loss
$

Total
Surplus

Total
Capital

$ 135

$ 270

—

18

18

18

$ 153

$ 306

—

59

87

87

(28)

(28)

(28)

(28)

$ 212

$ 424

—

18
—

18

$ 153

$ 153

$

—

59
—

    Adjustment to initially apply
        FASB Statement No. 158

—

Balance at December 31, 2006
(4.2 million shares)

$ 212

87

$ 240

$

The accompanying notes are an integral part
of these financial statements.

2006 Annual Report

38

Federal Reserve Bank of Dallas

Notes to Financial Statements
1. Structure
The Federal Reserve Bank of Dallas (“Bank”) is part of the Federal Reserve System
(“System”) and one of the twelve Reserve Banks (“Reserve Banks”) created by Congress
under the Federal Reserve Act of 1913 (“Federal Reserve Act”), which established the
central bank of the United States. The Reserve Banks are chartered by the federal government and possess a unique set of governmental, corporate, and central bank characteristics. The Bank and its branches in El Paso, Houston, and San Antonio serve the
Eleventh Federal Reserve District, which includes Texas and portions of Louisiana and
New Mexico.
In accordance with the Federal Reserve Act, supervision and control of the Bank are exercised by a board of directors. The Federal Reserve Act specifies the composition of the
board of directors for each of the Reserve Banks. Each board is composed of nine members serving three-year terms: three directors, including those designated as chairman
and deputy chairman, are appointed by the Board of Governors of the Federal Reserve
System (“Board of Governors”) to represent the public, and six directors are elected by
member banks. Banks that are members of the System include all national banks and
any state-chartered banks that apply and are approved for membership in the System.
Member banks are divided into three classes according to size. Member banks in each
class elect one director representing member banks and one representing the public. In
any election of directors, each member bank receives one vote, regardless of the number
of shares of Reserve Bank stock it holds.
The System also consists, in part, of the Board of Governors and the Federal Open
Market Committee (“FOMC”). The Board of Governors, an independent federal agency,
is charged by the Federal Reserve Act with a number of specific duties, including general
supervision over the Reserve Banks. The FOMC is composed of members of the Board of
Governors, the president of the Federal Reserve Bank of New York (“FRBNY”), and on a
rotating basis four other Reserve Bank presidents.
2. Operations and Services
The Reserve Banks perform a variety of services and operations. Functions include participation in formulating and conducting monetary policy; participation in the payments
system, including large-dollar transfers of funds, automated clearinghouse (“ACH”) operations, and check collection; distribution of coin and currency; performance of fiscal agency functions for the U.S. Treasury, certain federal agencies, and other entities; serving as
the federal government’s bank; provision of short-term loans to depository institutions;
service to the consumer and the community by providing educational materials and
information regarding consumer laws; and supervision of bank holding companies, state
member banks, and U.S. offices of foreign banking organizations. The Reserve Banks also
provide certain services to foreign central banks, governments, and international official
institutions.
The FOMC, in the conduct of monetary policy, establishes policy regarding domestic
open market operations, oversees these operations, and annually issues authorizations
and directives to the FRBNY for its execution of transactions. The FRBNY is authorized
and directed by the FOMC to conduct operations in domestic markets, including the
direct purchase and sale of U.S. government securities, the purchase of securities under
agreements to resell, the sale of securities under agreements to repurchase, and the
lending of U.S. government securities. The FRBNY executes these open market transactions at the direction of the FOMC and holds the resulting securities, with the exception
of securities purchased under agreements to resell, in the portfolio known as the System
Open Market Account (“SOMA”).

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2006 Annual Report

In addition to authorizing and directing operations in the domestic securities market,
the FOMC authorizes and directs the FRBNY to execute operations in foreign markets
for major currencies in order to counter disorderly conditions in exchange markets or
to meet other needs specified by the FOMC in carrying out the System’s central bank
responsibilities. The FRBNY is authorized by the FOMC to hold balances of, and to execute spot and forward foreign exchange (“FX”) and securities contracts for, nine foreign
currencies and to invest such foreign currency holdings ensuring adequate liquidity is
maintained. The FRBNY is authorized and directed by the FOMC to maintain reciprocal
currency arrangements (“FX swaps”) with two central banks and “warehouse” foreign
currencies for the U.S. Treasury and Exchange Stabilization Fund (“ESF”) through the
Reserve Banks. In connection with its foreign currency activities, the FRBNY may enter
into transactions that contain varying degrees of off-balance-sheet market risk that results
from their future settlement and counter-party credit risk. The FRBNY controls credit
risk by obtaining credit approvals, establishing transaction limits, and performing daily
monitoring procedures.
Although the Reserve Banks are separate legal entities, in the interests of greater efficiency and effectiveness they collaborate in the delivery of certain operations and services. The collaboration takes the form of centralized operations and product or service
offices that have responsibility for the delivery of certain services on behalf of the Reserve
Banks. Various operational and management models are used and are supported by service agreements between the Reserve Bank providing the service and the other eleven
Reserve Banks. In some cases, costs incurred by a Reserve Bank for services provided
to other Reserve Banks are not shared; in other cases, the Reserve Banks are billed for
services provided to them by another Reserve Bank.
Major services provided on behalf of the System by the Bank, for which the costs were
not redistributed to the other Reserve Banks, include the Bulkdata Transmission Utility;
Check Automation Services; National Examination Data System; Desktop Standardization
Initiative; Lawson Central Business Administration Function; Accounts, Risk and Credit
SM
System; and Go Direct .
During 2005, the Federal Reserve Bank of Atlanta (“FRBA”) was assigned the overall
responsibility for managing the Reserve Banks’ provision of check services to depository
institutions, and, as a result, recognizes total System check revenue on its Statements of
Income. Because the other eleven Reserve Banks incur costs to provide check services,
a policy was adopted by the Reserve Banks in 2005 that required that the FRBA compensate the other Reserve Banks for costs incurred to provide check services. In 2006
this policy was extended to the ACH services, which are managed by the FRBA, as well
as to Fedwire funds transfer and securities transfer services, which are managed by the
FRBNY. The FRBA and the FRBNY compensate the other Reserve Banks for the costs
incurred to provide these services. This compensation is reported as a component of
“Compensation received for services provided,” and the Bank would have reported $51
million as compensation received for services provided had this policy been in place in
2005 for ACH, Fedwire funds transfer, and securities transfer services.
3. Significant Accounting Policies
Accounting principles for entities with the unique powers and responsibilities of the
nation’s central bank have not been formulated by accounting standard-setting bodies.
The Board of Governors has developed specialized accounting principles and practices
that it considers to be appropriate for the nature and function of a central bank, which
differ significantly from those of the private sector. These accounting principles and
practices are documented in the Financial Accounting Manual for Federal Reserve Banks
(“Financial Accounting Manual”), which is issued by the Board of Governors. All of the
Reserve Banks are required to adopt and apply accounting policies and practices that are
consistent with the Financial Accounting Manual, and the financial statements have been
prepared in accordance with the Financial Accounting Manual.

2006 Annual Report

40

Federal Reserve Bank of Dallas

Differences exist between the accounting principles and practices in the Financial
Accounting Manual and generally accepted accounting principles in the United States
(“GAAP”), primarily due to the unique nature of the Bank’s powers and responsibilities as
part of the nation’s central bank. The primary difference is the presentation of all securities holdings at amortized cost, rather than using the fair value presentation required by
GAAP. Amortized cost more appropriately reflects the Bank’s securities holdings given
its unique responsibility to conduct monetary policy. While the application of current
market prices to the securities holdings may result in values substantially above or below
their carrying values, these unrealized changes in value would have no direct effect on
the quantity of reserves available to the banking system or on the prospects for future
Bank earnings or capital. Both the domestic and foreign components of the SOMA portfolio may involve transactions that result in gains or losses when holdings are sold prior
to maturity. Decisions regarding securities and foreign currency transactions, including
their purchase and sale, are motivated by monetary policy objectives rather than profit.
Accordingly, market values, earnings, and any gains or losses resulting from the sale of
such securities and currencies are incidental to the open market operations and do not
motivate decisions related to policy or open market activities.
In addition, the Bank has elected not to present a Statement of Cash Flows because the
liquidity and cash position of the Bank are not a primary concern given the Bank’s unique
powers and responsibilities. A Statement of Cash Flows, therefore, would not provide any
additional meaningful information. Other information regarding the Bank’s activities is
provided in, or may be derived from, the Statements of Condition, Income, and Changes
in Capital. There are no other significant differences between the policies outlined in the
Financial Accounting Manual and GAAP.
The preparation of the financial statements in conformity with the Financial Accounting
Manual requires management to make certain estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of income and
expenses during the reporting period. Actual results could differ from those estimates.
Certain amounts relating to the prior year have been reclassified to conform to the current-year presentation. Unique accounts and significant accounting policies are explained
below.
a. Gold and Special Drawing Rights Certificates

The Secretary of the U.S. Treasury is authorized to issue gold and special drawing rights
(“SDR”) certificates to the Reserve Banks.
Payment for the gold certificates by the Reserve Banks is made by crediting equivalent
amounts in dollars into the account established for the U.S. Treasury. The gold certificates
held by the Reserve Banks are required to be backed by the gold of the U.S. Treasury.
The U.S. Treasury may reacquire the gold certificates at any time, and the Reserve Banks
must deliver them to the U.S. Treasury. At such time, the U.S. Treasury’s account is
charged, and the Reserve Banks’ gold certificate accounts are reduced. The value of gold
for purposes of backing the gold certificates is set by law at $42 2/9 a fine troy ounce.
The Board of Governors allocates the gold certificates among Reserve Banks once a year
based on the average Federal Reserve notes outstanding in each Reserve Bank.
SDR certificates are issued by the International Monetary Fund (“Fund”) to its members in
proportion to each member’s quota in the Fund at the time of issuance. SDR certificates
serve as a supplement to international monetary reserves and may be transferred from
one national monetary authority to another. Under the law providing for United States participation in the SDR system, the Secretary of the U.S. Treasury is authorized to issue SDR
certificates, somewhat like gold certificates, to the Reserve Banks. When SDR certificates
are issued to the Reserve Banks, equivalent amounts in dollars are credited to the account
established for the U.S. Treasury, and the Reserve Banks’ SDR certificate accounts are
increased. The Reserve Banks are required to purchase SDR certificates, at the direction of
the U.S. Treasury, for the purpose of financing SDR acquisitions or for financing exchange
Federal Reserve Bank of Dallas

41

2006 Annual Report

stabilization operations. At the time SDR transactions occur, the Board of Governors allocates SDR certificate transactions among Reserve Banks based upon each Reserve Bank’s
Federal Reserve notes outstanding at the end of the preceding year. There were no SDR
transactions in 2006 or 2005.
b. Loans to Depository Institutions

Depository institutions that maintain reservable transaction accounts or nonpersonal
time deposits, as defined in regulations issued by the Board of Governors, have borrowing privileges at the discretion of the Reserve Bank. Borrowers execute certain lending
agreements and deposit sufficient collateral before credit is extended. Outstanding loans
are evaluated for collectibility, and currently all are considered collectible and fully collateralized. If loans were ever deemed to be uncollectible, an appropriate reserve would
be established. Interest is accrued using the applicable discount rate established at least
every fourteen days by the board of directors of the Reserve Bank, subject to review and
determination by the Board of Governors.
c. U.S. Government Securities and Investments Denominated in Foreign Currencies

U.S. government securities and investments denominated in foreign currencies comprising the SOMA are recorded at cost, on a settlement-date basis, and adjusted for amortization of premiums or accretion of discounts on a straight-line basis. Interest income
is accrued on a straight-line basis. Gains and losses resulting from sales of securities are
determined by specific issues based on average cost. Foreign-currency-denominated
assets are revalued daily at current foreign currency market exchange rates in order to
report these assets in U.S. dollars. Realized and unrealized gains and losses on investments denominated in foreign currencies are reported as “Foreign currency gains (losses), net” in the Statements of Income.
Activity related to U.S. government securities, including the premiums, discounts, and
realized and unrealized gains and losses, is allocated to each Reserve Bank on a percentage basis derived from an annual settlement of interdistrict clearings that occurs in
April of each year. The settlement also equalizes Reserve Bank gold certificate holdings
to Federal Reserve notes outstanding in each District. Activity related to investments
denominated in foreign currencies is allocated to each Reserve Bank based on the ratio
of each Reserve Bank’s capital and surplus to aggregate capital and surplus at the preceding December 31.
d. Securities Sold Under Agreements to Repurchase and Securities Lending

Securities sold under agreements to repurchase are accounted for as financing transactions, and the associated interest expense is recognized over the life of the transaction.
These transactions are reported in the Statements of Condition at their contractual
amounts, and the related accrued interest payable is reported as a component of “Other
liabilities.”
U.S. government securities held in the SOMA are lent to U.S. government securities
dealers in order to facilitate the effective functioning of the domestic securities market.
Securities-lending transactions are fully collateralized by other U.S. government securities, and the collateral taken is in excess of the market value of the securities loaned. The
FRBNY charges the dealer a fee for borrowing securities, and the fees are reported as a
component of “Other income.”
Activity related to securities sold under agreements to repurchase and securities lending
is allocated to each of the Reserve Banks on a percentage basis derived from the annual
settlement of interdistrict clearings. Securities purchased under agreements to resell are
allocated to FRBNY and not allocated to the other Reserve Banks.
e. FX Swap Arrangements and Warehousing Agreements

FX swap arrangements are contractual agreements between two parties, the FRBNY and
an authorized foreign central bank, to exchange specified currencies, at a specified price,
on a specified date. The parties agree to exchange their currencies up to a prearranged

2006 Annual Report

42

Federal Reserve Bank of Dallas

maximum amount and for an agreed-upon period of time (up to twelve months), at an
agreed-upon interest rate. These arrangements give the FOMC temporary access to the
foreign currencies it may need to intervene to support the dollar and give the authorized
foreign central bank temporary access to dollars it may need to support its own currency. Drawings under the FX swap arrangements can be initiated by either party acting
as drawer, and must be agreed to by the drawee party. The FX swap arrangements are
structured so that the party initiating the transaction bears the exchange rate risk upon
maturity. The FRBNY will generally invest the foreign currency received under an FX
swap arrangement in interest-bearing instruments.
Warehousing is an arrangement under which the FOMC agrees to exchange, at the
request of the U.S. Treasury, U.S. dollars for foreign currencies held by the U.S. Treasury
or ESF over a limited period of time. The purpose of the warehousing facility is to supplement the U.S. dollar resources of the U.S. Treasury and ESF for financing purchases of
foreign currencies and related international operations.
FX swap arrangements and warehousing agreements are revalued daily at current market exchange rates. Activity related to these agreements, with the exception of the unrealized gains and losses resulting from the daily revaluation, is allocated to each Reserve
Bank based on the ratio of each Reserve Bank’s capital and surplus to aggregate capital
and surplus at the preceding December 31. Unrealized gains and losses resulting from the
daily revaluation are allocated to FRBNY and not allocated to the other Reserve Banks.
f.		Bank Premises, Equipment, and Software

Bank premises and equipment are stated at cost less accumulated depreciation.
Depreciation is calculated on a straight-line basis over the estimated useful lives of the
assets, which range from two to fifty years. Major alterations, renovations, and improvements are capitalized at cost as additions to the asset accounts and are depreciated over
the remaining useful life of the asset or, if appropriate, over the unique useful life of the
alteration, renovation, or improvement. Maintenance, repairs, and minor replacements
are charged to operating expense in the year incurred.
Costs incurred for software during the application development stage, either developed
internally or acquired for internal use, are capitalized based on the cost of direct services and materials associated with designing, coding, installing, or testing software.
Capitalized software costs are amortized on a straight-line basis over the estimated useful
lives of the software applications, which range from two to five years. Maintenance costs
related to software are charged to expense in the year incurred.
Capitalized assets including software, buildings, leasehold improvements, furniture, and
equipment are impaired when events or changes in circumstances indicate that the carrying amount of assets or asset groups is not recoverable and significantly exceeds their
fair value.
g. Interdistrict Settement Account

At the close of business each day, each Reserve Bank assembles the payments due to or
from other Reserve Banks. These payments result from transactions between Reserve
Banks and transactions that involve depository institution accounts held by other Reserve
Banks, such as Fedwire funds transfer, check collection, security transfer, and ACH operations. The cumulative net amount due to or from the other Reserve Banks is reflected in
the “Interdistrict settlement account” in the Statements of Condition.
h. Federal Reserve Notes

Federal Reserve notes are the circulating currency of the United States. These notes are
issued through the various Federal Reserve agents (the chairman of the board of directors of each Reserve Bank and their designees) to the Reserve Banks upon deposit with
such agents of specified classes of collateral security, typically U.S. government securities.
These notes are identified as issued to a specific Reserve Bank. The Federal Reserve Act

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2006 Annual Report

provides that the collateral security tendered by the Reserve Bank to the Federal Reserve
agent must be at least equal to the sum of the notes applied for by such Reserve Bank.
Assets eligible to be pledged as collateral security include all of the Bank’s assets. The
collateral value is equal to the book value of the collateral tendered, with the exception
of securities, for which the collateral value is equal to the par value of the securities
tendered. The par value of securities pledged for securities sold under agreements to
repurchase is deducted.
The Board of Governors may, at any time, call upon a Reserve Bank for additional security
to adequately collateralize the Federal Reserve notes. To satisfy the obligation to provide
sufficient collateral for outstanding Federal Reserve notes, the Reserve Banks have entered
into an agreement that provides for certain assets of the Reserve Banks to be jointly
pledged as collateral for the Federal Reserve notes issued to all Reserve Banks. In the event
that this collateral is insufficient, the Federal Reserve Act provides that Federal Reserve
notes become a first and paramount lien on all the assets of the Reserve Banks. Finally,
Federal Reserve notes are obligations of the United States and are backed by the full faith
and credit of the United States government.
“Federal Reserve notes outstanding, net” in the Statements of Condition represents the
Bank’s Federal Reserve notes outstanding, reduced by the currency issued to the Bank
but not in circulation, of $19,391 million and $17,163 million at December 31, 2006 and
2005, respectively.
i.		 Items in Process of Collection and Deferred Credit Items

“Items in process of collection” in the Statements of Condition primarily represents
amounts attributable to checks that have been deposited for collection and that, as of
the balance sheet date, have not yet been presented to the paying bank. “Deferred credit
items” are the counterpart liability to items in process of collection, and the amounts in
this account arise from deferring credit for deposited items until the amounts are collected. The balances in both accounts can vary significantly.
j.		 Capital Paid-in

The Federal Reserve Act requires that each member bank subscribe to the capital stock
of the Reserve Bank in an amount equal to 6 percent of the capital and surplus of the
member bank. These shares are nonvoting with a par value of $100 and may not be
transferred or hypothecated. As a member bank’s capital and surplus change, its holdings of Reserve Bank stock must be adjusted. Currently, only one-half of the subscription
is paid-in and the remainder is subject to call. By law, each Reserve Bank is required to
pay each member bank an annual dividend of 6 percent on the paid-in capital stock. This
cumulative dividend is paid semiannually. A member bank is liable for Reserve Bank
liabilities up to twice the par value of stock subscribed by it.
k. Surplus

The Board of Governors requires the Reserve Banks to maintain a surplus equal to the
amount of capital paid-in as of December 31 of each year. This amount is intended to
provide additional capital and reduce the possibility that the Reserve Banks would be
required to call on member banks for additional capital.
Accumulated other comprehensive income is reported as a component of surplus in
the Statements of Condition and the Statements of Changes in Capital. The balance of
accumulated other comprehensive income is comprised of expenses, gains, and losses
related to defined benefit pension plans and other postretirement benefit plans that,
under accounting principles, are included in comprehensive income but excluded from
net income. Additional information regarding the classifications of accumulated other
comprehensive income is provided in Notes 9 and 10.

2006 Annual Report

44

Federal Reserve Bank of Dallas

l.		 Interest on Federal Reserve Notes

The Board of Governors requires the Reserve Banks to transfer excess earnings to the U.S.
Treasury as interest on Federal Reserve notes, after providing for the costs of operations,
payment of dividends, and reservation of an amount necessary to equate surplus with
capital paid-in. This amount is reported as a component of “Payments to U.S. Treasury
as interest on Federal Reserve notes” in the Statements of Income and is reported as a
liability in the Statements of Condition. Weekly payments to the U.S. Treasury may vary
significantly.
In the event of losses or an increase in capital paid-in at a Reserve Bank, payments to
the U.S. Treasury are suspended and earnings are retained until the surplus is equal to
the capital paid-in.
In the event of a decrease in capital paid-in, the excess surplus, after equating capital
paid-in and surplus at December 31, is distributed to the U.S. Treasury in the following
year.
m. Income and Costs Related to U.S. Treasury Services

The Bank is required by the Federal Reserve Act to serve as fiscal agent and depository
of the United States. By statute, the Department of the Treasury is permitted, but not
required, to pay for these services.
n. Assessments by the Board of Governors

The Board of Governors assesses the Reserve Banks to fund its operations based on each
Reserve Bank’s capital and surplus balances as of December 31 of the previous year. The
Board of Governors also assesses each Reserve Bank for the expenses incurred for the U.S.
Treasury to issue and retire Federal Reserve notes based on each Reserve Bank’s share
of the number of notes comprising the System’s net liability for Federal Reserve notes on
December 31 of the previous year.
o. Taxes

The Reserve Banks are exempt from federal, state, and local taxes, except for taxes on
real property. The Bank’s real property taxes were $3 million and $4 million for the years
ended December 31, 2006 and 2005, respectively, and are reported as a component of
“Occupancy expense.”
p. Restructuring Charges

In 2003, the Reserve Banks began the restructuring of several operations, primarily
check, cash, and U.S. Treasury services. The restructuring included streamlining the
management and support structures, reducing staff, decreasing the number of processing locations, and increasing processing capacity in some locations. These restructuring
activities continued in 2004 through 2006.
Note 11 describes the restructuring and provides information about the Bank’s costs and
liabilities associated with employee separations and contract terminations. The costs
associated with the impairment of certain of the Bank’s assets are discussed in Note 6.
Costs and liabilities associated with enhanced pension benefits in connection with the
restructuring activities for all of the Reserve Banks are recorded on the books of the
FRBNY. Costs and liabilities associated with enhanced postretirement benefits are discussed in Note 9.
q. Implementation of FASB Statement No. 158, Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans

The Bank initially applied the provisions of FASB Statement No. 158, Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans, at December
31, 2006. This accounting standard requires recognition of the overfunded or underfunded status of a defined benefit postretirement plan in the Statements of Condition,
and recognition of changes in the funded status in the years in which the changes occur
through comprehensive income. The transition rules for implementing the standard

Federal Reserve Bank of Dallas

45

2006 Annual Report

require applying the provisions as of the end of the year of initial implementation with
no retrospective application. The incremental effects on the line items in the Statements
of Condition at December 31, 2006, were as follows (in millions):

Accrued benefit costs
Total liabilities

Before
Application of
Statement 158
63
$ 40,212

28

$ 40,240

240

(28)

212

452

$ (28)

Surplus
Total capital

$

Adjustments
28
$

After
Application of
Statement 158
91

$

424

4. U.S. Government Securities, SECURITIES SOLD UNDER AGREEMENTS TO
REPURCHASE, AND SECURITIES LENDING
The FRBNY, on behalf of the Reserve Banks, holds securities bought outright in the
SOMA. The Bank’s allocated share of SOMA balances was approximately 4.488 percent
and 4.925 percent at December 31, 2006 and 2005, respectively.
The Bank’s allocated share of U.S. Government securities, net, held in the SOMA at
December 31, was as follows (in millions):
Par value:
U.S. government
Bills
Notes
Bonds
Total par value
Unamortized premiums
Unaccreted discounts
Total allocated to the Bank

2006

2005

$ 12,432
18,058
4,467
34,957
391
(180)
$35,168

$ 13,361
18,721
4,572
36,654
434
(139)
$36,949

At December 31, 2006 and 2005, the fair value of the U.S. government securities allocated to the Bank, excluding accrued interest, was $35,719 million and $37,799 million,
respectively, as determined by reference to quoted prices for identical securities.
The total of the U.S. government securities, net, held in the SOMA was $783,619 million and $750,202 million at December 31, 2006 and 2005, respectively. At December
31, 2006 and 2005, the fair value of the U.S. government securities held in the SOMA,
excluding accrued interest, was $795,900 million and $767,472 million, respectively, as
determined by reference to quoted prices for identical securities.
Although the fair value of security holdings can be substantially greater or less than the
carrying value at any point in time, these unrealized gains or losses have no effect on
the ability of a Reserve Bank, as a central bank, to meet its financial obligations and
responsibilities, and should not be misunderstood as representing a risk to the Reserve
Banks, their shareholders, or the public. The fair value is presented solely for informational purposes.
At December 31, 2006 and 2005, the total contract amount of securities sold under agreements to repurchase was $29,615 million and $30,505 million, respectively, of which
$1,329 million and $1,502 million were allocated to the Bank. The total par value of the
SOMA securities that were pledged for securities sold under agreements to repurchase at
December 31, 2006 and 2005, was $29,676 million and $30,559 million, respectively, of
which $1,332 million and $1,505 million was allocated to the Bank. The contract amount
for securities sold under agreements to repurchase approximates fair value.

2006 Annual Report

46

Federal Reserve Bank of Dallas

The maturity distribution of U.S. government securities bought outright, and securities
sold under agreements to repurchase, that were allocated to the Bank at December 31,
2006, was as follows (in millions):

   
Within 15 days
16 days to 90 days
91 days to 1 year
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years
Total allocated to the Bank

    U.S. Government
    Securities
    (Par value)
$ 1,822
8,118
8,308
10,061
3,036
3,612
$ 34,957

Securities Sold Under
Agreements to
Repurchase
(Contract amount)
$ 1,329
—
—
—
—
    —
$ 1,329

At December 31, 2006 and 2005, U.S. government securities with par values of $6,855
million and $3,776 million, respectively, were loaned from the SOMA, of which $308
million and $186 million, respectively, were allocated to the Bank.
5. Investments Denominated in Foreign Currencies
The FRBNY, on behalf of the Reserve Banks, holds foreign currency deposits with foreign
central banks and with the Bank for International Settlements and invests in foreign government debt instruments. Foreign government debt instruments held include both securities bought outright and securities purchased under agreements to resell. These investments are guaranteed as to principal and interest by the issuing foreign governments.
The Bank’s allocated share of investments denominated in foreign currencies was
approximately 1.154 percent and 1.146 percent at December 31, 2006 and 2005, respectively.
The Bank’s allocated share of investments denominated in foreign currencies, including
accrued interest, valued at foreign currency market exchange rates at December 31, was
as follows (in millions):
European Union Euro:
Foreign currency deposits
Securities purchased under agreements to resell
Government debt instruments
Japanese Yen:
Foreign currency deposits
Government debt instruments
Total allocated to the Bank

2006

2005

$ 72
25
47

$ 62
22
41

30
62
$236

30
62
$217

At December 31, 2006 and 2005, the fair value of investments denominated in foreign
currencies, including accrued interest, allocated to the Bank was $236 million and $217
million, respectively. The fair value of government debt instruments was determined
by reference to quoted prices for identical securities. The cost basis of foreign currency
deposits and securities purchased under agreements to resell, adjusted for accrued interest, approximates fair value. Similar to the U.S. government securities discussed in Note
4, unrealized gains or losses have no effect on the ability of a Reserve Bank, as a central
bank, to meet its financial obligations and responsibilities.

Federal Reserve Bank of Dallas

47

2006 Annual Report

Total System investments denominated in foreign currencies were $20,482 million and
$18,928 million at December 31, 2006 and 2005, respectively. At December 31, 2006
and 2005, the fair value of the total System investments denominated in foreign currencies, including accrued interest, was $20,434 million and $18,965 million, respectively.
The maturity distribution of investments denominated in foreign currencies that were
allocated to the Bank at December 31, 2006, was as follows (in millions):
European
Euro
$ 50
27
28
39
—
—
$ 144

Within 15 days
16 days to 90 days
91 days to 1 year
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years
Total allocated to the Bank

Japanese
Yen
$ 30
14
26
22
—
—
$ 92

Total
$ 80
41
54
61
—
—
$236

At December 31, 2006 and 2005, there were no material open foreign exchange
contracts.
At December 31, 2006 and 2005, the warehousing facility was $5,000 million, with no
balance outstanding.
6.	Bank Premises, equipment, and Software
A summary of bank premises and equipment at December 31 is as follows (in millions):
Bank premises and equipment:
Land
Buildings
Building machinery and equipment
Construction in progress
Furniture and equipment
   Subtotal
Accumulated depreciation
Bank premises and equipment, net
Depreciation expense, for the year ended
      December 31

2006

2005

$   60
222
36
2
75
395
(101)
$294

$56
220
36
2
75
389
(92)
$297

$ 13

$ 11

The Bank leases space to outside tenants with remaining lease terms ranging from one to
nine years. Rental income from such leases was $174 thousand and $101 thousand for
the years ended December 31, 2006 and 2005, respectively, and is reported as a component of “Other income.” Future minimum lease payments that the Bank will receive
under noncancelable lease agreements in existence at December 31, 2006, are as follows
(in thousands):
2007
2008
2009
2010
2011
Thereafter
Total

2006 Annual Report

$

183
182
182
186
189
649
$  1,571

48

Federal Reserve Bank of Dallas

The Bank has capitalized software assets, net of amortization, of $6 million and $5 million at December 31, 2006 and 2005, respectively. Amortization expense was $2 million
for each of the years ended December 31, 2006 and 2005. Capitalized software assets
are reported as a component of “Other assets,” and the related amortization is reported
as a component of “Other expenses.”
The Bank had no impairment losses in 2006 and 2005.
7. Commitments and Contingencies
At December 31, 2006, the Bank was obligated under noncancelable leases for premises
and equipment with remaining terms ranging from two to approximately four years.
These leases provide for increased rental payments based upon increases in real estate
taxes, operating costs, or selected price indices.
Rental expense under operating leases for certain operating facilities, warehouses, and
data processing and office equipment (including taxes, insurance and maintenance when
included in rent), net of sublease rentals, was $212 thousand and $1 million for the years
ended December 31, 2006 and 2005, respectively. Certain of the Bank’s leases have
options to renew.
Future minimum rental payments under noncancelable operating leases and capital
leases, net of sublease rentals, with terms of one year or more, at December 31, 2006,
were not material.
At December 31, 2006, there were no other material commitments or long-term obligations in excess of one year.
Under the Insurance Agreement of the Federal Reserve Banks, each of the Reserve Banks
has agreed to bear, on a per incident basis, a pro rata share of losses in excess of 1
percent of the capital paid-in of the claiming Reserve Bank, up to 50 percent of the total
capital paid-in of all Reserve Banks. Losses are borne in the ratio that a Reserve Bank’s
capital paid-in bears to the total capital paid-in of all Reserve Banks at the beginning of the
calendar year in which the loss is shared. No claims were outstanding under the agreement at December 31, 2006 or 2005.
The Bank is involved in certain legal actions and claims arising in the ordinary course
of business. Although it is difficult to predict the ultimate outcome of these actions, in
management’s opinion, based on discussions with counsel, the aforementioned litigation
and claims will be resolved without material adverse effect on the financial position or
results of operations of the Bank.
8. Retirement and Thrift Plans
		 Retirement Plans

The Bank currently offers three defined benefit retirement plans to its employees, based
on length of service and level of compensation. Substantially all of the Bank’s employees participate in the Retirement Plan for Employees of the Federal Reserve System
(“System Plan”). Employees at certain compensation levels participate in the Benefit
Equalization Retirement Plan (“BEP”), and certain Reserve Bank officers participate in the
Supplemental Employee Retirement Plan (“SERP”).
The System Plan is a multi-employer plan with contributions funded by the participating employers. Participating employers are the Federal Reserve Banks, the Board of
Governors, and the Office of Employee Benefits of the Federal Reserve Employee Benefits
System. No separate accounting is maintained of assets contributed by the participating
employers. The FRBNY acts as a sponsor of the System Plan, and the costs associated
with the Plan are not redistributed to other participating employers.

Federal Reserve Bank of Dallas

49

2006 Annual Report

The Bank’s projected benefit obligation, funded status, and net pension expenses for the
BEP and the SERP at December 31, 2006 and 2005, and for the years then ended, were
not material.
		 Thrift Plan

Employees of the Bank may also participate in the defined contribution Thrift Plan for
Employees of the Federal Reserve System (“Thrift Plan”). The Bank’s Thrift Plan contributions totaled $4 million and $3 million for the years ended December 31, 2006 and
2005, respectively, and are reported as a component of “Salaries and other benefits” in
the Statements of Income. The Bank matches employee contributions based on a specified formula. For the years ended December 31, 2006 and 2005, the Bank matched 80
percent on the first 6 percent of employee contributions for employees with less than
five years of service and 100 percent on the first 6 percent of employee contributions for
employees with five or more years of service.
9. Postretirement Benefits Other Than Pensions and Postemployment Benefits
		 Postretirement Benefits Other Than Pensions

In addition to the Bank’s retirement plans, employees who have met certain age and lengthof-service requirements are eligible for both medical benefits and life insurance coverage
during retirement.
The Bank funds benefits payable under the medical and life insurance plans as due and,
accordingly, has no plan assets.
Following is a reconciliation of beginning and ending balances of the benefit obligation
(in millions):
Accumulated postretirement benefit obligation at January 1
Service cost-benefits earned during the period
Interest cost on accumulated benefit obligation
Actuarial loss
Contributions by plan participants
Benefits paid
Accumulated postretirement
benefit obligation at December 31

2006
$ 67.5
2.1
4.0
12.1
1.0
(3.8)

2005
$ 59.4
1.6
3.5
5.7
0.9
(3.6)

$ 82.9

$ 67.5

At December 31, 2006 and 2005, the weighted-average discount rate assumptions used
in developing the postretirement benefit obligation were 5.75 percent and 5.50 percent,
respectively.
Discount rates reflect yields available on high-quality corporate bonds that would generate
the cash flows necessary to pay the plan’s benefits when due.
Following is a reconciliation of the beginning and ending balance of the plan assets, the
unfunded postretirement benefit obligation, and the accrued postretirement benefit costs
(in millions):

2006 Annual Report

50

Federal Reserve Bank of Dallas

Fair value of plan assets at January 1
Contributions by the employer
Contributions by plan participants
Benefits paid
Fair value of plan assets at December 31

2006
$      —
    2.8
1.0
(3.8)
$
—

2005
—
2.7
0.9
(3.6)
$
—

Unfunded postretirement benefit obligation

$  82.9

$   67.5

Unrecognized prior service cost
Unrecognized net actuarial loss
Accrued postretirement benefit cost

$

3.2
(20.7)
$ 50.0

Amounts included in accumulated other
     comprehensive loss are shown below (in millions):
Prior service cost
Net actuarial loss
Total accumulated other comprehensive loss

$     2.7
    (31.0)
    $ (28.3)

Accrued postretirement benefit costs are reported as a component of “Accrued benefit
costs” in the Statements of Condition.
For measurement purposes, the assumed health care cost trend rates at December 31 are
as follows:
2006

2005

Health care cost trend rate assumed for next year

  9.00%

   9.00%

Rate to which the cost trend rate is assumed to decline
     (the ultimate trend rate)

  5.00%

   5.00%

2012

   2011

Year that the rate reaches the ultimate trend rate

Assumed health care cost trend rates have a significant effect on the amounts reported for
health care plans. A one percentage point change in assumed health care cost trend rates
would have the following effects for the year ended December 31, 2006 (in millions):
One Percentage One Percentage
Point Increase Point Decrease
Effect on aggregate of service and interest cost components
of net periodic postretirement benefit costs
Effect on accumulated postretirement benefit obligation

$

1.1
11.0

$

(0.9)
(9.1)

The following is a summary of the components of net periodic postretirement benefit
expense for the years ended December 31 (in millions):
Service cost-benefits earned during the period
Interest cost on accumulated benefit obligation
Amortization of prior service cost
Recognized net actuarial loss
Net periodic postretirement benefit expense
Estimated amounts that will be amortized from
     accumulated other comprehensive loss into net
     periodic postretirement benefit expense in 2007
     are shown below (in millions):
Prior service cost
Actuarial loss
Total

Federal Reserve Bank of Dallas

2006
2.1
4.0
(0.4)
1.8
$ 7.5

$

                      $    (0.4)
              3.1
$

51

2005
1.6
3.5
(0.4)
1.2
$ 5.9

$

2.7

2006 Annual Report

Net postretirement benefit costs are actuarially determined using a January 1 measurement date. At January 1, 2006 and 2005, the weighted-average discount rate assumptions
used to determine net periodic postretirement benefit costs were 5.50 percent and 5.75
percent, respectively
Net periodic postretirement benefit expense is reported as a component of “Salaries and
other benefits” in the Statements of Income.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 established
a prescription drug benefit under Medicare (“Medicare Part D”) and a federal subsidy to
sponsors of retiree health care benefit plans that provide benefits that are at least actuarially equivalent to Medicare Part D. The benefits provided under the Bank’s plan to certain
participants are at least actuarially equivalent to the Medicare Part D prescription drug
benefit. The estimated effects of the subsidy, retroactive to January 1, 2004, are reflected
in actuarial loss in the accumulated postretirement benefit obligation.
There were no receipts of federal Medicare subsidies in the year ended December 31,
2006. Expected receipts in the year ending December 31, 2007, related to payments
made in the year ended December 31, 2006, are $0.2 million.
Following is a summary of expected postretirement benefit payments (in millions):
Without Subsidy
2007
2008
2009
2010
2011
2012–2016

$

Total

$ 56.4

With Subsidy

4.0
4.3
4.8
5.2
5.6
32.5

$

3.7
4.0
4.4
4.8
5.1
29.3

$ 51.3

		 Postemployment Benefits

The Bank offers benefits to former or inactive employees. Postemployment benefit costs
are actuarially determined using a December 31 measurement date and include the cost
of medical and dental insurance, survivor income, and disability benefits. The accrued
postemployment benefit costs recognized by the Bank were $7 million for each of the
years ended December 31, 2006 and 2005. This cost is included as a component of
“Accrued benefit costs” in the Statements of Condition. Net periodic postemployment
benefit expenses included in operating expenses were $1 million for each of the years
ended December 31, 2006 and 2005, and are recorded as a component of “Salaries and
other benefits” in the Statements of Income.
10. ACCUMULATED OTHER COMPREHENSIVE INCOME
Following is a reconciliation of beginning and ending balances of accumulated other comprehensive loss (in millions):
Amount Related to Postretirement
Benefits Other Than Pensions
Balance at December 31, 2005
   Adjustment to initially apply
       FASB Statement No. 158
Balance at December 31, 2006

$        —
(28)
$     (28)

Additional detail regarding the classification of accumulated other comprehensive loss is
included in Note 9.

2006 Annual Report

52

Federal Reserve Bank of Dallas

11. BUSINESS Restructuring Charges
In 2006, the Bank announced plans for restructuring to streamline its Houston operations
and reduce costs. These actions resulted in the following business restructuring charges
(in millions):
					

Year ended December 31, 2006
Total
Estimated
Costs

Accrued
Liability
12/31/05

Total
Charges

Total
Paid

Accrued
Liability
12/31/06

Employee separation

$

1

$

—

$

1

$  —

   $     1

Total

$

1

$

—

$

1

$  —

   $    1

Employee separation costs are primarily severance costs related to identified staff reductions of approximately 33 related to restructuring announced in 2006. Costs related to
staff reductions for the year ended December 31, 2006, are reported as a component of
“Salaries and other benefits” in the Statements of Income.
Costs associated with enhanced pension benefits for all Reserve Banks are recorded on
the books of the FRBNY as discussed in Note 8. Costs associated with enhanced postretirement benefits are disclosed in Note 9.
The Bank anticipates substantially completing its announced plans by July 2007.

The firm engaged by the Board of Governors for the audits of the individual and combined
financial statements of the Reserve Banks for 2006 was PricewaterhouseCoopers LLP (PwC).
Fees for these services totaled $4.2 million. To ensure auditor independence, the Board of
Governors requires that PwC be independent in all matters relating to the audit. Specifically,
PwC may not perform services for the Reserve Banks or others that would place it in a
position of auditing its own work, making management decisions on behalf of the Reserve
Banks, or in any other way impairing its audit independence. In 2006, the Bank did not
engage PwC for any material advisory services.

Federal Reserve Bank of Dallas

53

2006 Annual Report

Volume of Operations
(unaudited)
Number of Items Handled
(Thousands)
2006

Dollar Amount
(Millions)

2005

2006

2005

SERVICES TO DEPOSITORY INSTITUTIONS
cash services
Federal Reserve notes processed

2,970,987

2,730,220

53,050

44,499

Currency received from circulation

3,074,837

2,691,171

53,304

45,490

738,927

430,458

81

46

Commercial–processed

942,688

882,076

1,052,639

880,988

Commercial–fine sorted

9,563

11,991

8,206

6,299

259

147

0

356

Coin received from circulation

check processing

loans
Advances made

79*

67*

SERVICES TO THE U.S. TREASURY
AND GOVERNMENT AGENCIES
Issues and reinvestments
of Treasury securities

0

10

*Individual loans, not in thousands.

2006 Annual Report

54

Federal Reserve Bank of Dallas

About the Dallas Fed
The Federal Reserve Bank of Dallas is one of 12 regional
Federal Reserve Banks in the United States. Together
with the Board of Governors in Washington, D.C., these
organizations form the Federal Reserve System and function
as the nation’s central bank. The System’s basic purpose
is to provide a flow of money and credit that will foster
orderly economic growth and a stable dollar. In addition,
Federal Reserve Banks supervise banks and bank holding
companies and provide certain financial services to the
banking industry, the federal government and the public.
The Federal Reserve Bank of Dallas has served the
financial institutions in the Eleventh District since 1914. The
district encompasses 350,000 square miles and comprises
the state of Texas, northern Louisiana and southern New
Mexico. The three branch offices of the Dallas Fed are in El
Paso, Houston and San Antonio.
Gloria V. Brown, Vice President, Public Affairs
Kay Champagne, Managing Editor
Monica Reeves, Editor

Tonya Abna, Art Director

Gene Autry, Photographer

Federal Reserve Bank
of Dallas
2200 North Pearl Street
Dallas, TX 75201
214-922-6000
El Paso Branch
301 East Main Street
El Paso, TX 79901
915-521-5200
Houston Branch
1801 Allen Parkway
Houston, TX 77019
713-483-3000
San Antonio Branch
126 East Nueva Street
San Antonio, TX 78204
210-978-1200
Web Site
www.dallasfed.org